The art (or science) of business valuation

Business Valuation is neither a science nor an art. There is no universally accepted framework or template to get a precise answer. Though there are various models available, input to those models are based on judgement and that comes from hands-on experience. Value estimated using any of the available models is a range of numbers and that range becomes starting point for negotiation.

Same set of assets can be valued differently by different group of people. For example, a buyer would value an asset higher because she is expecting to realize some synergy from combining the assets with her own assets. At the same time, a seller would value the same asset lower because that’s the reason he is selling that asset in first place.

There may be gap between intrinsic value and market value of an asset. Price of a security in capital market may not reflect its fundamental value. Market may not have confidence of the strategies or capabilities of a company unless implemented and hence put lower value to its stock.  There may be liquidity issue in the market. Sentiments play a big role in the market. There may be temporary fluctuation in the price of a security. Hence, market value should not be taken as the intrinsic value of an asset. We should strive to estimate the intrinsic value of the asset (or a business).

Setting the right context is probably the most important thing for business valuation. Depending on the purpose of the valuation, an asset can have different value. Valuation for the purpose of M&A may be totally different from that of an analyst’s perspective who may be interested in determining whether a firm is overvalued or undervalued. A manager may be interested in estimating value of the business so that she could evaluate different alternative strategies and choose the one that adds most value. With a long-term value creation for the stakeholders perspective, a company may adopt a strategy that is making loss in short-term. There may be different valuation from legal or accounting perspective. Different businesses of a conglomerate may benefit from group synergies such as economy of scale/scope or brand but if that conglomerate decides to sell a business, the buyer won’t value those synergies.

Valuation is subjective in nature and depends heavily on the correctness of the assumptions made by the valuer. Hence it is quite easy for biases of the valuer to creep into her valuation. For example, if a valuer likes a company very much then she may be very optimistic about the future potential of that company. Similarly, if she had some bad experience with a company then she may have pessimistic view about the future of that company. Public news about a company can also have some influence of its valuation. To avoid such biases in valuation, one should use multiple methods of valuation. If she is not getting similar values then, without tinkering with the value itself, she should check her assumptions and assess their validity.