Valuation: What's it worth?

 

Valuation: What's it worth?

https://myinvestingnotes.blogspot.com/2009/11/valuation-whats-it-worth.html

Business Valuation: A Practical Guide for Investors

When assessing a business's worth, understand there is no single "right" answer. Valuation is a blend of art and science. Use multiple methods to triangulate a fair value, and always seek independent professional advice. Here are the four core techniques you need to know.

1. Asset Valuation (The Floor Price)

• What it is: The business's liquidation value.

• How it works: Assets – Liabilities = Net Asset Value.

• Investor Insight: This sets the absolute minimum price. It tells you what you could recover if the business closed today. It ignores future profit potential and intangibles like brand reputation (goodwill). Useful for asset-heavy or underperforming businesses, but will understate the value of any profitable, going concern.

2. Capitalised Future Earnings (The Income Standard)

• What it is: The most common method for small businesses. It values the stream of future profits.

• How it works: (Adjusted Average Net Profit ÷ Desired Rate of Return) x 100.

• Investor Insight: This method answers a key question: "What price gives me my target return?" The critical input is your required rate of return, which must reflect the business's risk. A higher risk demands a higher return, which lowers the price you should pay. Compare this return to other investments (e.g., stocks, bonds) to gauge attractiveness.

3. Earnings Multiple (The Market Shortcut)

• What it is: A quick, market-driven method based on a profitability metric.

• How it works: Earnings Before Interest & Tax (EBIT) x Industry Multiple.

• Investor Insight: Its power is simplicity, but the multiple is everything. Multiples range widely (often 1x to 6x for private companies) based on industry, growth potential, and profit stability. Action: Consult brokers to find the current multiple for similar businesses. This method is excellent for cross-checking against the Capitalised Earnings result.

4. Comparable Sales (The Reality Check)

• What it is: The market-based benchmark—what are similar businesses actually selling for?

• How it works: Research recent, arms-length sales of comparable businesses in your sector.

• Investor Insight: This grounds your valuation in market reality. Just like real estate, recent "comps" are the ultimate price determinant. Speak to multiple brokers and scan industry listings. If your calculated value is far from market prices, re-examine your assumptions.

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Investor Action Plan

1. Calculate All Four: Run the numbers using each method to establish a value range.

2. Weight the Methods: For a profitable service business, emphasize Earnings methods. For a struggling capital-intensive firm, the Asset value may be key.

3. Stress-Test Key Inputs: Vary your required rate of return and earnings multiple. How sensitive is the valuation?

4. Quantify Goodwill: If paying above asset value, identify what you're paying for (customer base, location, brand). Is it transferable?

5. Get the Data: Use Comparable Sales to anchor your offer in the real market.

6. Engage a Professional: A business valuer or broker provides critical, objective analysis and market intelligence.

Final Warning: Valuation is the starting point for negotiation, not the final price. The true "worth" is what a informed buyer is willing to pay and a motivated seller is willing to accept, based on a disciplined analysis of these fundamentals.