How to Value a Company
How much is a company worth? This is the fundamental question that many analysts operating in financial markets seek to answer.
This applies whether the company in question:
- Is listed on an organized stock exchange, which means it has a share price available to the public, or
- Is a private company, which means it does not have a published share price
For all analysts, the key question that they have to address is "what is value"?
One answer is that value is simply what one party is willing to pay and another party is willing to accept. But there is no definite answer to this question, since corporate valuation is as much of an art as it is a science.
That said, there are a number of common techniques that financial analysts employ to arrive at a start-point in the value negotiation.
Related article: What is Corporate Finance?
Related article: What is Corporate Finance?
How Are Companies Valued in Practice?
The most widely-accepted objective of any business entity is that of maximizing value for its owners/shareholders. Therefore, in pursuit of this objective, an understanding of corporate valuation is vital.
So, how are companies valued in practice? It is the role of many analysts engaged in financial services to come up with an answer to this question. For instance, the approach to valuing a private company differs from that of a public company.
Public companies have a listed stock price, enabling investors to buy or sell shares depending on their view about how the price might change.
Investment managers are employed to pick stocks to add to investment portfolios based on their potential to increase in value. Equity researchers assist them in their job by providing additional information about a company's future plans and projections, helping to identify potentially under- or overvalued stocks.
Other companies are private, so do not have a listed share price. These companies may choose to list in the future through an initial public offering (IPO), may be bought out by another company, may seek additional equity investment by a third party, or may choose to stay privately owned.
Although there is no publicly-available stock price, if the company chooses to list on an exchange, seeks to be taken over by another company, or wants additional equity investment, then it must engage bankers to help determine its value and figure out what the stock price should be.
There are three main methods of valuing companies, one of which is an absolute valuation method, and two of which are relative valuation methods.
Ultimately, value is simply what one party is willing to pay and what another party is willing to accept. Investment banking analysts compile valuations using the different methods and draw the analysis together to provide information that acts as a start-point for negotiations.
Discounted Cash Flow (DCF) Analysis (Absolute Valuation)
DCF valuation is the practice of estimating all of the future cash flows of a company and discounting them back to present value to derive a value for the company today.
Trading Comparables Analysis (Relative Valuation)
Trading comparables (or comparable company) valuation methods compare similar companies to the target company and work out how much the market is willing to pay for the company relative to different financial benchmarks. These values are then used to imply a valuation for the target company.
Transaction Comparables Analysis (Relative Valuation)
Transaction comparables valuation examines recently completed deals to see what value the markets have been assigning to similar transactions. From this, analysts can get an assessment of current market conditions and build them into the company valuation.
Factors Affecting Valuations
There are many factors that analysts may try to quantify in their analysis which may later have an impact on the ultimate valuation once the buyer and seller meet at the negotiating table.
Some of these factors are difficult to quantify precisely. Examples of factors that affect valuations but may be difficult to quantify include:
- Current market conditions
- Need for a quick sale by the seller
- Willingness of the seller to be bought-out
- Strategic gains the buyer may make from the purchase
- Availability of synergies from the deal
- Prevailing economic conditions
- Relative size of target and acquirer
For this reason, investment bankers prefer to give a valuation range that factors in the worst-case scenarios to give a low-end valuation and the best-case scenarios for the likely high-end valuation.