Saturday, 18 February 2012

How should investors choose among these several valuation methods?

How should investors choose among these several valuation methods?  When is one clearly preferable to the others?  When one method yields very different values from the others, which should be trusted?

At times a particular method may stand out as the most appropriate.  

  • Net present value would be most applicable, for example, in valuing a high-return business with stable cash flows such as a consumer-products company; its liquidation value would be far too low.
  • Similarly, a business with regulated rates of return on assets such as a utility might best be valued using NPV analysis.  
  • Liquidation analysis is probably the most appropriate method for valuing an unprofitable business whose stock trades well below book value.  
  • A closed-ended fund or other company that owns only marketable securities should be valued by the stock market method, no other makes sense.

Often several valuation methods should be employed simultaneously.  

  • To value a complex entity such as a conglomerate operating several distinct businesses, for example, some portion of the assets might be best valued using one method and the rest with another.  
Frequently investors will want to use several methods to value a single business in order to obtain a range of values.  

  • In this case investors should err on the side of conservatism, adopting lower values over higher ones unless there is strong reasons to do otherwise.  
  • True, conservatism may cause investors to refrain from making some investments that in hindsight would have been successful, but it will also prevent some sizable losses that would ensue from adopting less conservative business valuations.

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