Business Valuations Masterclass Notes

Speaker Introduction

• Name: Andrew Moer
• Affiliation: Tutor at Kaplan Financial
• Session Aim: Overview of four main business valuation methods
  1. Asset-based valuations
  2. Dividend-based valuations (Dividend Valuation Model)
  3. Price Earnings (P/E) Ratios
  4. Discounted Cash Flows (DCF)

Asset-Based Valuations

• Basic Concept: Company value = Assets - Liabilities
• Methods to Determine Asset Values:
  • Book Values: From the statement of financial position.
  • Net Realizable Value: What the company would receive if it sold all its assets.
  • Replacement Cost: Cost to build the business from scratch.

Advantages

• Simple and straightforward calculation.
• Quick access to information from financial statements.
• Useful in negotiations, especially for sellers.
• Effective for loss-making or asset-heavy companies.

Disadvantages

• Outdated Information: Values may not reflect current market conditions.
• Ignores Intangibles: Does not account for brand value, skills, customer base, etc.
• No Growth Potential Consideration: Does not assess future earnings, only current assets.

Dividend Valuation Model (DVM)

• Basic Concept: Company value based on future dividends.
• Formula:
  [ V = \frac{D(1 + g)}{k_e - g} ]
  where V = value, D = dividend, g = growth rate, k_e = cost of equity.

Advantages

• Incorporates future growth and expected returns for investors.
• Can assess minority shareholdings effectively.

Disadvantages

• Assumes Constant Growth: Growth rate g is assumed to remain constant.
• Relies on Cost of Equity: Difficulty in determining a constant cost of equity.
• Not Applicable to All Companies: Companies that do not pay dividends cannot use this method.

Price Earnings (P/E) Ratios

• Basic Concept: Value = Earnings × Suitable P/E Ratio.
• Finding a Suitable P/E Ratio: Compare with similar companies or industry averages.

Advantages

• Based on real data from similar listed companies.
• Takes into account brand and reputation through earnings.
• Quick and widely used method.

Disadvantages

• Subject to Variability: P/E ratios are estimates and may not accurately reflect differences between companies.
• Historical Earnings Use: Relies on past performance rather than future forecasts.
• Non-marketability Adjustment Needed: For unlisted companies, a deduction (usually around 25%) is applied to reflect lower marketability.

Discounted Cash Flow (DCF) Technique

• Basic Concept: Value = Present Value of Future Cash Flows.
• Setup: Typically involves forecasting cash flows over several years and a final perpetuity calculation.

Advantages

• Highly detailed and accurate because it forecasts cash flows.
• Considers both growth and the factual nature of cash flows.

Disadvantages

• Reliance on Forecasts: Future predictions can be uncertain.
• Complexity: More time-consuming than other methods.
• Sensitive to Assumptions: Small changes in the cost of capital can significantly affect valuations.

Conclusion

• Overview of four business valuation methods:
  • Asset-based valuations
  • Dividend-based valuations
  • P/E ratios
  • Discounted Cash Flows
• Understanding pros and cons of each method is crucial for evaluations in exams.