CORPORATE EVALUATION

The Fundamental Concept of Corporate Valuation

Suraj Dubey Email: [email protected] [email protected] Phone: 9920880152

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Introduction - Concept of Fair Value ▪

What is equity valuation? ‘Fair Value’ alue’ of a company’s equity in order to assist buy/sell decisions for the purpose of financial or strategic A process that involves determining ‘Fair investment.

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What is Fair Value Value of an investment? Fair Value is the price at which, one will get the desired rate of return when the investment is sold to a willing & able buyer. The worth of an investment is determined by whether it is meant for long-term use to generate returns (Strategic Investment) or for resale when the right price or fair value is achieved (Financial Investment). The purpose of valuation is to determine a fair value range of an investment (or capital asset) using one or more of several available techniques/methods.

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How should the worth of an Investment Investment be determined? Investment related demand is generally driven by expected return resulting from the demand for other similar opportunities available, potential to







Introduction - Who uses Valuation? Valuation Valua tion is used at two levels ▪ ▪

Primary, which deals with ‘Value Creation’ at a corporate finance level Secondary, Secondary, that deals with market market intermediaries & investors investors

Buy Side Institutions

Buy Sid Side e refer referss to those institution institutionss that are engaged engaged in buying buying research research conducted conducted by others. others. They invest/manage client’s funds (as well as their own) into investments in primary or secondary markets. Primary market refers to direct investment in companies while secondary involves buying/selling stocks in the stock market. E.g. - Mutual Funds, Hedge Funds, Private Equity Firms & Venture Capitalists (any Asset Management Company).







Valuation Approaches ▪

Why not have just one approach? The idea is to capture all dimensions that a investor may be concerned with. Unfortunately Unfortunately,, no single valuation methodology is complete and hence two or more approaches are necessary to arrive at a ‘fair value range’. range’.

Income based

Market based

Asset based

Income based approaches aim to discover value of a firm through its income metrics like Net profit or Free Cash Flows etc. Popular methods - DCF - DCF Valuation, Economic Value Added (EVA) model etc.

Market based approaches aim to capture market sentiment while also taking into account peer comparison. E.g. Trading & Transaction Comparables Popular methods - Relative - Relative Valuation (P/E, P/B, Price/Sales, EV/EBITDA, EV/Sales, etc.)

Asset based approaches aim to value a firm by valuing its assets on a carry value, replacement value or liquidation value basis Popular methods - Liquidation - Liquidation value approach, Replacement cost method and Book Value







Valuation Methods Discounted Cash Flows DCF Valuation aims to discover the ‘Intrinsic Value’ of a company by estimating present value of future cash flows. Sub Methods: Enterprise valuation valuation (FCF/F) (FCF/F) Equity method (FCFE) (FCFE) Economic Profit Model (EVA) (EVA) Adjusted present present value approach (APV)

Trading Comparables Relative Valuation aims to determine valuation by peer comparison and hence captures market sentiment Sub Methods: Equity & Enterprise Multiples •

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M&A Valuation Although not an entirely different methodology it deals with judging the feasibility of a merger/acquisition using slightly modified techniques Methods Used: Accretion/Dilution Analysis (measures whether EPS increases or decreases post deal) Transaction Transaction Comparables (scrutinizes historical transactions for ‘deal •

Pros: Capture market market sentiment Quick & easy to apply Works between quarters •

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Other Methods Other methods some of which are ‘academic’ in nature and not so popular and hence best left in books. Methods: First Chicago Chicago approach Contingent claim valuation Edwards, Bell & Ohlson model Dividend discount model Liquidation value approach approach Replacement cost approach approach • •

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Best Valuation Method ▪

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There is no best method. method. Apart from the pros/cons, pros/cons, each method is designed to suit: investment investment horizon, investment investment type, market market conditions, sector, scenario and so on. Investment Horizon & Valuation Investment Horizon i.e. Short Term or Long term investor is typically interested in determining fair value between quarterly results. Although DCF provides an intrinsic value, in the short run, share prices may be very volatile and DCF will not help such an investor in any way. Hence, short term investors (speculators/traders) must rely on trends, sentiments and news to determine valuation. These factors are best captured in the Comparables Method (Relative Valuation). Valuation). On the other hand , long term investors rely on DCF, DCF, as it goes beyond the shor t term trend and provide true potential of a n investment.

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Market Conditions & Valuation Bullish & Bearish Markets call for different valuation strategies and hence different methodologies. In bullish markets, many shift from DCF to Comparables in the pretext that ‘DCF fails to capture that the market as a whole has moved to a higher level’. However, they fail to recognize that without DCF, the valuation is ‘floating’ and is no longer tied to an intrinsic value. The opposite prevails in case of bearish markets, when analysts rely on DCF, now claiming that Comparables understate









Best Valuation Method: Public vs Private







Best Valuation Method: Business-wise Start-ups







Best Valuation Method: Sector-wise Basic materials







General Concepts Why do share prices move move up?







General Concepts What does economic profit profit mean? mean?























CORPORATE EVALUATION

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