Valuation Flashcards
Asset based approach
ADVANTAGES
Simple to calculate
Assets are more certain than income
Useful for asset strippers if there are valuable tangible assets
DISADVANTAGES
Book values are likely to be out of date
Ignores future earnings
Service businesses would be undervalued due to the value of intangibles
Ignores the value of digital assets so undervalues companies with valuable content that is stored electronically
Income based approach
ADVANTAGES
Technically the best method, especially for service businesses
Incorporates all available relevant cash flows and the time value of money
DISADVANTAGES
Estimated cash flows may be too optimistic, especially the terminal value of a perpetuity
Calculating a suitable discount rate can be problematic, especially for unlisted companies
Price-Earnings ratio valuation
ADVANTAGES
Reflects the stock market’s view of the potential of a company
Considers the earnings created potential of the company
DISADVANTAGES
Using an industry average or proxy company’s P/E ratio may not properly reflect the company being valued
Earnings can be manipulated by accounting policies
Using past earnings may not reflect future potential
Enterprise/EBITDA multiple method
ADVANTAGES
It is unaffected by the capital structure or depreciation policies of a company
It takes net debt into account
Enables direct comparison between companies which might have different policies
It is the technique most commonly used by investors
DISADVANTAGES
It is simplistic- a lot of information from many value drivers is distilled into a single number
Ignoring CAPEX and tax could be a disadvantage in some circumstances- management can be for example potentially add value through skilled tax management
Using past earnings may not reflect future potential
Using an industry average or proxy multiple may not properly reflect the company being valued
Dividend valuation method and dividend yield
ADVANTAGES
Most effective when the investor is looking for dividend income rather than control
DISADVANTAGES
Dividend payments and growth may not be stable
Using the dividend yield or a Ke of a proxy company or industry average may not reflect the company being valued
