A-pre valuation intro

• Going-Concern Value:

  • Firm value determined under the going concern assumption
  • Assumes the company will remain in business indefinitely and continue to be profitable
  • Definition of value varies depending on the context and objective of valuation
• Liquidation Value:

  • Net amount realized if the business is terminated and assets are sold on a piecemeal basis
  • An estimation of the final value received by the holder of financial instruments when an asset is sold or liquidated
  • Typically lower than fair market value
• Intrinsic Value:

  • A measure of what an asset is worth arrived at by objective calculation or complex financial models
  • Price a rational investor is willing to pay given the level of risk
  • Considered as the "true" or "real" value
• Fair Market Value:

  • Price expressed in terms of cash at which property or an asset would change hands
  • Involves a hypothetical willing and able buyer and seller in an open, unrestricted market
  • Assumes both parties are informed of all material characteristics about the investment that might influence their decision
• Roles of Valuation in Business:

  • Portfolio Management:
  • Depends on investment objectives of investors
  • Passive investors are disinterested, while active investors may want to understand valuation to participate intelligently in the stock market
  • Investors rely on professionals to know when to buy or sell
  • Analysis of Business Transactions/Deals:
  • Valuation plays a significant role in analyzing potential deals
  • Potential acquirers use relevant valuation techniques to estimate the value of target firms they plan to acquire
• Analysis of Business Transactions/Deals:

  • Corporate Events:
  • Acquisition: buying firm and selling firm
  • Merger: two companies combine assets
  • Divestiture: sale of major component or business segment to another entity
  • Spin-off: separating a segment or component into a new legal entity
  • Leveraged Buy-Out: acquisition of another business using significant debt
• Analysis of Business Transactions/Deals:

  • Reasons for Divestiture:
  • Not part of core business
  • Need to generate funds
  • Lack of internal talent for business
  • Regulatory environment or tax structure
  • Opportunistic approach
  • Important factors in valuation in deals analysis:
  • Synergy: potential increase in firm value post-merger
  • Control: important in hostile takeovers
• Roles of Valuation in Business:

  • Corporate Finance:
  • Involves managing the firm's capital structure
  • Prioritizes and distributes financial resources to activities that increase firm value
  • Legal and Tax Purposes in Valuating Business:
  • Company assets should be properly valued for tax purposes
  • Helps set a realistic price, aids in decision-making, and resolves partnership disputes
• Valuation Process:

  • Understanding the Business:
  • Includes performing industry and competitive analysis
  • Factors considered: economic conditions, industry peculiarities, company strategy, historical performance
• Valuation Process:

  • Understanding the Business:
  • Industry Structure:
  • Capital Intensity
  • Advertising Intensity
  • Firm Concentration
  • Average company size
• Valuation Process:

  • Understanding the Business:
  • Porter's Five Forces:

  1. Industry Rivalry

  2. New Entrants

  3. Substitutes and Complements

  4. Suppliers Power

  5. Buyer Power
• Valuation Process:

  • Understanding the Business:
  • Competitive Position and Competitive Advantage:
  • Competitive Position: how the company is set apart from competitors
  • Competitive Advantage: how a company excels compared to rivals
• Valuation Process:

  • Understanding the Business:
  • Generic Corporate Strategies:

  1. Cost Leadership

  2. Differentiation

  3. Focus
• Valuation Process:

  • Understanding the Business:
  • Business Model:
  • Historical financial statements analysis
  • Horizontal analysis
  • Vertical analysis
  • Ratio analysis
• Vertical analysis involves comparing line items in financial statements to evaluate the proportions of each item to a base item within the same period
• Common-size financial statements are converted financial statements expressed in percentages or currency to facilitate comparison
• Ratio analysis is the comparison of line items in financial statements to evaluate the performance and financial health of a business
• Ethically, analysts should only use publicly available information for their analysis
• Quality earnings analysis involves a detailed review of financial statements and accompanying notes to assess the sustainability of company performance and validate the accuracy of financial information
• Quality earnings analysis also compares net income against operating cash flow to ensure reported earnings are realizable to cash and not inflated through significant accrual entries
• Red flags that may indicate aggressive accounting practices include:

  • Poor quality of accounting disclosure
  • Related-party transactions
  • Disputes with changes in auditor
  • Non-audit services performed by the audit firm
  • Management compensation tied to profitability or stock price
  • High management turnover
  • Pressure on company personnel to generate revenue
  • Pressure to meet debt covenants or earnings expectations
  • History of securities law violations or reporting violations
• Forecasting financial performance involves considering insights from industry, competitive, and business strategy analysis when forecasting sales, operating income, and cash flows
• Forecasting should be comprehensive, including earnings, cash flow, and balance sheet forecasts, and should consider industry financial ratios
• Two lenses for forecasting financial performance are:

  • Macro perspective: Economic environment and industry analysis
  • Micro perspective: Financial and operating characteristics
• Two approaches in forecasting financial performance are:

  A. Top-down forecasting approach: Focuses on demographics and target audience

  B. Bottom-up forecasting approach: Focuses on business activities to compete in the market
• The appropriate valuation model depends on the context of the valuation and the inherent characteristics of the company being valued
• When preparing a valuation model based on forecasts, consider the context of the valuation and the inherent characteristics of the company being valued
• Sensitivity analysis, also known as what-if analysis or simulation analysis, predicts outcomes after considering changes in variables affecting the situation
• Scenario modeling examines a range of potential futures instead of predicting just one future, helping assess risk
• After calculating the value based on all assumptions, analysts and investors use the results to provide recommendations or make decisions aligned with their investment objectives
• Key principles of business valuation:

  1. The value of a business is defined at a specific point in time and requires consistent monitoring

  2. Value varies based on the business's ability to generate future cash flows
• Key principles of business valuation:

  3. Market dictates the appropriate rate of return for investors, influencing discount rates and long-term returns

  4. Firm value can be impacted by underlying net tangible assets and transferability of future cash flows
• Key principles of business valuation:

  5. Value is influenced by liquidity, with companies meeting short-term obligations positively impacting their value
• Risks in valuation:

  • Uncertainty is present in all valuation exercises
  • Some methods use future estimates, which may differ significantly from actual outcomes
  • Analysts use judgment to ascertain assumptions based on available facts
  • Industry performance varies in predictability, introducing uncertainty
  • Innovations and new businesses can bring uncertainty to established companies