User Group session: Company Valuation

During this month's user group we focused on some of the nuances associated with valuing companies. Whilst there are a number of more quantitative approaches to valuation, that was not the focus of this session .

Our initial discussion focused on why there is a need to value companies. The main drivers are:

• Company ownership is the predominant wealth creation

• Determines how good people are feeling about their financial position (ie if your company is becoming more valuable an individual will become more confident in their wealth)

• It is important to note that company ownership is Illiquid until sold

• Helps understand external investment from PE (ie what % they are gaining when buying in)

Instead of focusing on deriving key financials of a company and analysing reports, researchers should instead use their own judgment and research to establish a more qualitative view about how the company i.e. performing and how sustainable current performance is. As a group we established some key drivers including:

• Management quality

• Strategy

• Growth potential

• Sustainability

• Long term vision

• Reputation

• Good products / service

• Awards / recognition

• Innovative

• Diversity of management and staff

• Meets a need

• Clear product offering

• Barriers to entry

• Supportive economic conditions

• IP

• Customer service

• Clear marketing / positioning

These factors lead to long term value creation, free cash flow generation and profits. These are consequences of having good drivers (ie a profitable company is not profitable given it makes profits, more that profits are a result of good managers and having barriers to entry etc).

We then noted there are multiple technical approaches to valuing a company and that most of these require a substantial amount of data which is often not readily available:

• Discounted Cash flow

• Sustainable cash flow

• Turnover

• Profit (which op, ebitda, net income) Multiples

• Net assets

• Benchmark

We see many people / valuation approaches focused on the use of profits and net assets and we highlighted some of the predominant issues:
Problems of using net income as an input into valuation:

• Accounting profits not cash

• Easily adjusted with things sich as depreciation and amortisation etc

• Not transparent

• Which profit figure to use (there are many different profit figures reported and its sometimes tricky to establish which one is the right one to use!)

Problems of using net assets:

• In some businesses (such as consultancy) all profits could taken out as dividends, such businesses require minimal assets and so on paper the business is valued very low given the absence of any assets

• Reported tangible assets are not where the true value lies in many companies

• Historical

• Probably only applicable for real estate businesses.

When using Smart Valuation we then discussed a preference to focus on turnover and the number of employees, noting code does all the difficult work for you and you are advised to input any data you can access - code will do the rest!

We then quickly discussed some valuation considerations for housing companies, legal/consultancy and engineering companies.

Any questions please get in touch team@pyro.solutions

Thanks,
Jon