Corporate Valuation

Covid-19 an Uncertainty in Corporate Valuation

All assets, financial along with real, retain a value. The key to controlling these assets is rooted on accepting not only the appropriate value, but the origins of the value. All assets can be valued, but some assets are easier to value against others, and the required data can vary widely from company to company. Therefore, valuing a piece of real estate will require different financial data and depend on different valuation tools and follow a different format than the valuation of a publicly traded stock. Surprising, however, is not the characteristics in valuation methods across assets, but the level of similarity in traditional valuation fundamentals.

Tall Tales about Valuation

Like all analytical disciplines, valuation has established its very own set of tales over time. We look at a few of these and uncloak a number of these tall tales.

1. Valuation is not a science which some of its promoters make it out to be nor the objective pursuit for true value which visionary’s would like it to become. The financial models used in valuation may be quantitative, however, the inputs leave a lot of room for subjective decision making. So, the end value that we find using these models is altered by the predispositions (i.e., Covid-19) that we carry in to the analysis. In fact, in countless valuations, price is found first and the valuation follows.

The obvious fix is to remove all bias prior to beginning a valuation, but this is in fact much easier said than done. Given the resources we have to big data, research, and opinions about a firm, it is unlikely that we can embark on most valuations without some bias. Is Covid-19 a long-term harbinger or a short-term crisis?

2. A perfectly-researched and perfectly-done valuation is timeless.

The value derived from any valuation model is affected by firm-specific as well as market wide information. As a result, value can change as new information is revealed. Given the endless flow of information into financial markets, a valuation prepared on a company grows old fast and it has to be continuously updated in order to stay current. This information may be firm specific, impact an entire sector, or even alter expectations for a number of firms in the market. Would one discount revenues 20%-30% because of Covid-19. If so, for how long? We think a 3%-8% revenue discount (in specific sectors) through 2020 is appropriate, and in a few other markets the opposite (i.e., retail grocery and pharma).

Valuations can change, and when they do we will be pressured to justify the change. The best reaction may be the one that John Maynard Keynes offered when he had been criticized for altering his position on a major economic issue: "When the facts change, I change my mind. And what do you do, Sir?"

3. A good valuation provides a precise estimation of value.

Even after countless hours of painstaking and detailed analysis, there will be uncertainty about the ending valuation, colored as they are about our assumptions and expectations of the company and the economic future. It is impossible to forecast or expect total certainty in valuation, given how cash flows and discount rates are determined. This also suggests that analysts need to grant themselves a realistic margin of error when making recommendations based on their valuations.

4. The more complex the model, the more reliable the valuation.

It may seem obvious that building a more complex financial model should yield superior valuations; however, this is not necessarily so. As models become more quantitative, the number of data inputs needed to value a firm seemingly multiply, bringing with it the probability for input mistakes. These concerns are further heightened whenever models become so intertwined that they turn out to be "black boxes" where analysts commonly enter in numbers at one end and magically a value emerges from the other. All too often when a valuation breaks down, the criticism gets attached to the model not the experienced professional. The push back becomes "It was not my fault. Criticize the model."

The basis to a good valuation is parsimony, which states do not use more inputs than you absolutely need to construct a good valuation.

Valuation in Corporate Finance

The principle in corporate finance is to maximize company value; however, the link between financial decisions, corporate planning, and firm value needs to be defined. Today, management consulting firms are providing companies advice on how to enhance firm value. This advice is providing the basis for the remaking of these companies.

The value of a company can be tied directly to the financial outcomes that it produces - on the projects it takes, on how it finances them, and on its dividend policy. Recognizing these interconnections is critical to incorporating value-enhancing decisions and to a workable financial restructuring.

Is your company growth rate and profitable lower than your peers? Give us a call at 916-629-4660.

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