1. Doing an asset valuation
Now, doing an asset valuation is just a matter of working down the balance sheet.
- As you go through the balance sheet, you ask yourself what it costs to reproduce the various assets.
- Then for the intangibles list them like the product portfolio and ask what will be the cost reproducing that product portfolio.
For the EPV, you basically have to calculate two things:
- You have to calculate earnings power which is the current earnings that is adjusted in a variety of ways.
- You divide the normal earnings by the cost of capital.
- You have to adjust for any accounting shenanigans that are going on, you have to adjust for the cyclical situation, for the tax situation that may be short-lived, for excess depreciation over the cost of maintenance capital expense (MCX).
- And really for anything else that is going on that is causing current earnings to deviate from long run sustainable earnings.
- So valuation is calculated by a company’s long-run sustainable earnings multiplied by 1/cost of capital.
- What it means is say you have $4 billion in assets here that is producing an equivalent earnings power value of $2 billion.
- What is going there if that is the situation you see? It has got to be bad management.
- Management is using those assets in a way that cannot generate a comparable level of distributable earnings.
- If it is an industry in decline, make sure you haven’t done a reproduction value when you should be doing a liquidation value.
Notes from video lecture by Prof Bruce Greenwald