Earnings Multiple: A Valuation Method

 

Earnings Multiple: A Valuation Method

Among various methods for determining the value of a small business, the "earnings multiple" approach is almost universally considered to be the most acceptable and useful.

 

Those brokers in favor of the asset appraisal method believe the easiest and most accurate way to decide on a company's worth is simply to arrive at a sum by adding up the dollar value of all its assets. A machine shop--for example-- with its lathes, drills, stamping and milling machines should be worth what it would cost to purchase all of this equipment, plus the supplies and materials required for the machine shop operations.

 

Meanwhile, market comparable advocates, many of whom have a background in real estate sales, take the position that if you want to know what a business is worth, it's necessary only to find out the selling prices for other businesses that are similar to the one under study. That is, after all, the most popular way to figure out a price at which to sell a home. And this same valuation theory will be used by the appraiser hired by the bank considering a loan request from a would-be purchaser.

 

Unlike a home, however, a small business is not likely to have much in common with other businesses in the area, even those in the same industry. Operations affiliated with the same franchise company, and in neighboring communities, would seem to have much in common, and yet are rarely comparable. There will be differences in business volume, rent paid and other factors that influence profitability. The result is that when the two businesses go to market, they will bring different selling prices. This fact has been proved repeatedly by owners of multiple operations affiliated with a single franchisor, and located in neighboring communities. An added problem with this method is the dollar value of a business sale is not a matter of public record. Most everyone who is interested can find out the amount that was paid for the two-story Tudor style house on Main Street. But the prices recently paid for the restaurant, gas station and dress shop are not posted anywhere that can be viewed by the public. A business appraiser wanting to use the "market-comparables" system is at a distinct disadvantage because the information needed to establish a valuation is not available.

 

A MONEY MACHINE

 

The essential idea behind the earnings multiple valuation system is that a business is a mechanism for making an income--it's value a direct function of the amount of that income. The size of that "machine," the value of the equipment used to produce the income, the similarity with other businesses--these all are interesting facts, but not the determining factor when deciding what a company is worth. A machine shop, for example, may have assets with a value in the hundreds of thousands of dollars. But if, according to the "money machine" principal, it does not generate hundreds of thousands in earnings to the seller, it's value as a going entity will be less than the amount that could be raised by selling off its equipment. A seller whose company has more "scrap" value (measured by what the company's pieces would sell for) than "earnings" value might yield a better price by auctioning off the assets one by one.

 

An example often repeated by business brokers and small business valuation professionals describes a comparison between--

• on the one hand--a manufacturing company in a troubled industry with several hundred thousands in hard assets, but less than $3,500 per month in owner earnings, and
• on the other hand, a distributorship generating more than $20,000 per month in owner earnings, and operated successfully with little in the way of assets--perhaps just a fax-capable telephone and an address book.

 

The comparison is cited as a valuation problem to solve, posed as "which is more valuable as a going business?" and the right answer, of course, is the distributorship.

 

This and other examples serve to remind prospective buyers and sellers that most people in the market to buy a small business are seeking healthy cash flow. The multiple used in the formula may vary, based on the industry standard, but the valuation method of choice is almost always dependent on owner earnings.

http://www.usabizmart.com/blog/earnings-multiple-business-valuation-120508.php

A good article of PE (Earnings multiples)

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Price to Future Earnings

Price to Future Earnings

The price earnings ratio cannot be estimated for firms with negative earnings per share. While there are other multiples, such as the price to sales ratio, that can still be estimated for these firms, there are analysts who prefer the familiar ground of PE ratios.

One way in which the price earnings ratio can be modified for use in these firms is to use expected earnings per share in a future year in computing the PE ratio.

For instance, assume that a firm has earnings per share currently of -$2.00 but is expected to report earnings per share in 5 years of $1.50 per share. You could divide the price today by the expected earnings per share in five years to obtain a PE ratio.

How would such a PE ratio be used? The PE ratio for all of the comparable firms would also have to be estimated using expected earnings per share in 5 years and the resulting values can be compared across firms. Assuming that all of the firms in the sample share the same risk, growth and payout characteristics after year 5, firms with low price to future earnings ratios will be considered undervalued.

An alternative approach is to estimate a target price for the negative earnings firm in five years, divide that price by earnings in that year and compare this PE ratio to the PE ratio of comparable firms today.

While this modified version of the PE ratio increases the reach of PE ratios to cover many firms that have negative earnings today, it is difficult to control for differences between the firm being valued and the comparable firms, since you are comparing firms at different points in time.

Illustration: Analyzing Amazon using Price to Future Earnings per share Amazon.com has negative earnings per share in 2000. Based upon consensus estimates, analysts expect it to lose $0.63 per share in 2001 but is expected to earn $1.50 per share in 2004. At its current price of $49 per share, this would translate into a price/future earnings per share of 32.67.

In the first approach, this multiple of earnings can be compared to the price/future earnings ratios of comparable firms. If you define comparable firms to be e-tailers, Amazon looks reasonably attractive since the average price/future earnings per share of etailers
is 65. If, on the other hand, you compared Amazon’s price to future earnings per share to the average price to future earnings per share (in 2004) of specialty retailers, the picture is bleaker. The average price to future earnings for these firms is 12, which would lead to a conclusion that Amazon is over valued. Implicit in both these comparisons is the assumption that Amazon will have similar risk, growth and cash flow characteristics as the comparable firms in five years. You could argue that Amazon will still have much higher growth potential than other specialty retailers after 2004 and that this could explain the difference in multiples. You could even use differences in expected growth after 2004 to adjust for the differences, but estimates of these growth rates are usually not made by analysts.

In the second approach, the current price to earnings ratio for specialty retailers, which is estimated to be 20.31, and the expected earnings per share of Amazon in 2004, which is estimated to be $1.50. This would yield a target price of $30.46. Discounting this price back to the present using Amazon’s cost of equity of 12.94% results in a value per share.

= Target price in five years / (1+ Cost of equity)^5

Value per share
= 30.46 / (1.1294^5)
= $16.58

At its current price of $49, this would again suggest an over valued stock. Here again, though, you are assuming that Amazon in five years will resemble a specialty retailer today in terms of risk, growth and cash flow characteristics.


http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Relative PE Ratios and Market Growth

Relative PE Ratios and Market Growth

As the expected growth rate on the market increases, the divergence in PE ratios increases, resulting in a bigger range for relative PE ratios.

This can be illustrated very simply, if you consider the relative PE for a company that grows at half the rate as the market.

When the market growth rate is 4%, this firm will trade at a PE that is roughly 80% of the market PE. When the market growth rate increases to 10%, the firm will trade at a PE that is 60% of the market PE.

This has consequences for analysts who use relative PE ratios. Stocks of firms whose earnings grow at a rate much lower than the market growth rate, will often look cheap on a relative PE basis when the market growth rate is high, and expensive when the market growth rate is low.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Relative PE Ratios

 

Relative PE Ratios

 

Relative price earnings ratios measure a firm’s PE ratio relative to the market average. It is obtained by dividing a firm’s current PE ratio by the average for the market.

 

Relative PE = Current PE ratio (firm) / Current PE ratio (market)

 

Not surprisingly, the distribution of relative PE ratios mimics the distribution of the actual PE ratios, with one difference – the average relative PE ratio is one.

 

To analyze relative PE ratios, we will draw on the same model that we used to analyze the PE ratio for a firm in high growth, but we will use a similar model to estimate the PE ratio for the market. Brought together, we obtain the following.

Note that the relative PE ratio is a function of all of the variables that determine the PE ratio – the expected growth rate, the risk of the firm and the payout ratio – but stated in terms relative to the market. Thus, a firm’s relative PE ratio is a function of its relative growth rate in earnings per share (Growth Ratefirm/Growth Ratemarket), its relative cost of equity (Cost of Equityfirm/Cost of Equitymarket) and its relative return on equity (ROEfirm/ROEmarket). Firms with higher relative growth, lower relative costs of equity and higher relative returns on equity should trade at higher relative PE ratios.

There are two ways in which they are used in valuation.

• One is to compare a firm’s relative PE ratio to its historical norms; Ford, for instance, may be viewed as under valued because its relative PE ratio of 0.24 today is lower than the relative PE that it has historically traded at.
• The other is to compare relative PE ratios of firms in different markets; this allows comparisons when PE ratios in different markets vary significantly.

For instance, we could have divided the PE ratios for each telecom firm by the PE ratio for the market in which this firm trades locally to estimate relative PE ratios and compared those ratios.

Illustration:

Comparing Relative PE ratios for automobile stock – December 2000

In December 2000, the S&P 500 was trading at a multiple of 29.09 times earnings. At the same time, Ford, Chrysler and GM were trading at 7.05, 8.95 and 6.93 times earnings, respectively. Their relative PE ratios are reported.

Relative PE for Ford = 7.05 / 29.09 = 0.24

Relative PE for Chrysler = 8.95 / 29.09 = 0.30

Relative PE for GM = 6.93 / 29.09 = 0.24

Does this mean that GM and Ford are more under valued than Chrysler? Not necessarily, since there are differences in growth and risk across these firms. In fact, Figure 18.13 graphs the relative PE ratios of the three firms going back to the early 1990s. In 1993, GM traded at a significantly higher relative PE ratio than the other two firms. In fact, the conventional wisdom until that point in time was that GM was less risky than the other two firms because of its dominance of the auto market and should trade at a higher multiple of earnings. During the 1990s, the premium paid for GM largely disappeared and the three automobile firms traded at roughly the same relative PE ratios.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Whose Growth rate to use in PEG calculations?

Whose Growth rate?

In computing PEG ratios, we are often faced with the question of whose growth rate we will use in estimating the PEG ratios.

If the number of firms in the sample is small, you could estimate expected growth for each firm yourself.

If the number of firms increases, you will have no choice but to use analyst estimates of expected growth for the firms. Will this expose your analyses to all of the biases in these estimates? Not necessarily. If the bias is uniform – for instance, analysts over estimate growth for all of the firms in the sector – you will still be able to make comparisons of PEG ratios across firms and draw reasonable conclusions.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Using the PEG Ratio for Comparisons

 

Using the PEG Ratio for Comparisons

 

As with the PE ratio, the PEG ratio is used to compare the valuations of firms that are in the same business. The PEG ratio is a function of

• the risk,
• growth potential and
• the payout ratio of a firm.

In this section, you look at ways of using the PEG ratio and examine some of the problems in comparing PEG ratios across firms.

Direct Comparisons

PEG Ratios and Retention Ratios

Most analysts who use PEG ratios compute them for firms within a business (or comparable firm group) and compare these ratios.

Firms with lower PEG ratios are usually viewed as undervalued, even if growth rates are different across the firms being compared.

This approach is based upon the incorrect perception that PEG ratios control for differences in growth. In fact, direct comparisons of PEG ratios work only if firms are similar in terms of growth potential, risk and payout ratios (or returns on equity). If this were the case, however, you could just as easily compare PE ratios across firms.

When PEG ratios are compared across firms with different risk, growth and payout characteristics and judgments are made about valuations based on this comparison, you will tend to find that:

· Lower growth firms will have higher PEG ratios and look more over valued than higher growth firms, because PEG ratios tend to decrease as the growth rate decreases, at least initially.
· Higher risk firms will have lower PEG ratios and look more under valued than higher risk firms, because PEG ratios tend to decrease as a firm’s risk increases.
· Firms with lower returns on equity (or lower payout ratios) will have lower PEG ratios and look more under valued than firms with higher returns on equity and higher payout ratios.

In short, firms that look under valued based upon direct comparison of the PEG ratios may in fact be firms with higher risk, higher growth or lower returns on equity that are, in fact, correctly valued.



Controlled Comparisons

When comparing PEG ratios across firms, then, it is important that you control for differences in risk, growth and payout ratios when making the comparison. While you can attempt to do this subjectively, the complicated relationship between PEG ratios and these fundamentals can pose a challenge. A far more promising route is to use the regression approach suggested for PE ratios and to relate the PEG ratios of the firms being compared to measures of risk, growth potential and the payout ratio.

As with the PE ratio, the comparable firms in this analysis can be defined narrowly (as other firms in the same business), more expansively as firms in the same sector or as all firms in the market. In running these regressions, all the caveats that were presented for the PE regression continue to apply. The independent variables continue to be correlated with each other and the relationship is both unstable and likely to be nonlinear.

A scatter plot of PEG ratios against growth rates, for all U.S. stocks in July 2000, indicates the degree of non-linearity.

In running the regression, especially when the sample contains firms with very different levels of growth, you should transform the growth rate to make the relationship more linear. A scatter plot of PEG ratios against the natural log of the expected growth rate, for
instance, yields a much more linear relationship.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Using PEG ratio: Not all growth is created equal.

As the risk increases, the PEG ratio of a firm decreases. When comparing the PEG ratios of firms with different risk levels, even within the same sector, the riskier firms should have lower PEG ratios than safer firms.

 

Not all growth is created equal. A firm that is able to grow at 20% a year, while paying out 50% of its earnings to stockholders, has higher quality growth than another firm with the same growth rate that reinvests all of its earnings back. Thus, the PEG ratio should increase as the payout ratio increases, for any given growth rate.

As with the PE ratio, the PEG ratio is used to compare the valuations of firms that are in the same business.  The PEG ratio is a function of:

• the risk,
• growth potential and
• the payout ratio of a firm.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

The PEG Ratio

The PEG Ratio

Portfolio managers and analysts sometimes compare PE ratios to the expected growth rate to identify undervalued and overvalued stocks. In the simplest form of this approach, firms with PE ratios less than their expected growth rate are viewed as undervalued. In its more general form, the ratio of PE ratio to growth is used as a measure of relative value, with a lower value believed to indicate that a firm is under valued.

For many analysts, especially those tracking firms in high-growth sectors, these approaches offer the promise of a way of controlling for differences in growth across firms, while preserving the inherent simplicity of a multiple.


Definition of the PEG Ratio

The PEG ratio is defined to be the price earnings ratio divided by the expected growth rate in earnings per share:

PEG ratio =  PE ratio /Expected Growth Rate

For instance, a firm with a PE ratio of 20 and a growth rate of 10% is estimated to have a PEG ratio of 2.

Consistency requires the growth rate used in this estimate be the growth rate in earnings per share, rather than operating income, because this is an equity multiple.

Given the many definitions of the PE ratio, which one should you use to estimate the PEG ratio? The answer depends upon the base on which the expected growth rate is computed. If the expected growth rate in earnings per share is based upon earnings in the most recent year (current earnings), the PE ratio that should be used is the current PE ratio. If it based upon trailing earnings, the PE ratio used should be the trailing PE ratio.

The forward PE ratio should never be used in this computation, since it may result in a double counting of growth. To see why, assume that you have a firm with a current price of $30 and current earnings per share of $1.50. The firm is expected to double its earnings per share over the next year (forward earnings per share will be $3.00) and then have earnings growth of 5% a year for the following four years. An analyst estimating growth in earnings per share for this firm, with the current earnings per share as a base, will estimate a growth rate of 19.44%.

A consistent estimate of the PEG ratio would require using a current PE and the expected growth rate over the next 5 years.

Building upon the theme of uniformity, the PEG ratio should be estimated using the same growth estimates for all firms in the sample. You should not, for instance, use 5-year growth rates for some firms and 1-year growth rates for others. One way of ensuring uniformity is to use the same source for earnings growth estimates for all the firms in the group.

For instance, both I/B/E/S and Zacks provide consensus estimates from analysts of earnings per share growth over the next 5 years for most U.S. firms.

As the risk increases, the PEG ratio of a firm decreases.  When comparing the PEG ratios of firms with different risk levels, even within the same sector, the riskier firms should have lower PEG ratios than safer firms.

Not all growth is created equal. A firm that is able to grow at 20% a year, while paying out 50% of its earnings to stockholders, has higher quality growth than another firm with the same growth rate that reinvests all of its earnings back. Thus, the PEG ratio should increase as the payout ratio increases, for any given growth rate.
http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Normalizing Earnings for PE ratios

Normalizing Earnings for PE ratios

The dependence of PE ratios on current earnings makes them particularly vulnerable to the year-to-year swings that often characterize reported earnings.

In making comparisons, therefore, it may make much more sense to use normalized earnings.

The process used to normalize earnings varies widely but the most common approach is a simple averaging of earnings across time.

For a cyclical firm, for instance, you would average the earnings per share across a cycle. In doing so, you should adjust for inflation.

If you do decide to normalize earnings for the firm you are valuing, consistency demands that you normalize it for the comparable firms in the sample as well.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Comparing PE Ratios across firms in a sector

Comparing PE Ratios across firms in a sector

The most common approach to estimating the PE ratio for a firm is to choose a group of comparable firms, to calculate the average PE ratio for this group and to subjectively adjust this average for differences between the firm being valued and the comparable firms. There are several problems with this approach.

First, the definition of a comparable' firm is essentially a subjective one. The use of other firms in the industry as the control group is often not the solution because firms within the same industry can have very different business mixes and risk and growth profiles. There is also plenty of potential for bias. One clear example of this is in takeovers, where a high PE ratio for the target firm is justified, using the price-earnings ratios of a control group of other firms that have been taken over. This group is designed to give an upward biased estimate of the PE ratio and other multiples.

Second, even when a legitimate group of comparable firms can be constructed, differences will continue to persist in fundamentals between the firm being valued and this group. It is very difficult to subjectively adjust for differences across firms. Thus, knowing that a firm has much higher growth potential than other firms in the comparable firm list would lead you to estimate a higher PE ratio for that firm, but how much higher is an open question.

The alternative to subjective adjustments is to control explicitly for the one or two variables that you believe account for the bulk of the differences in PE ratios across companies in the sector in a regression. The regression equation can then be used to estimate predicted PE ratios for each firm in the sector and these predicted values can be compared to the actual PE ratios to make judgments on whether stocks are under or over priced.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Comparing PE ratios across Countries

Comparing PE ratios across Countries

Comparisons are often made between price-earnings ratios in different countries with the intention of finding undervalued and overvalued markets. Markets with lower PE ratios are viewed as under valued and those with higher PE ratios are considered over valued.

Given the wide differences that exist between countries on fundamentals, it is clearly misleading to draw these conclusions. For instance, you would expect to see the following, other things remaining equal:

· Countries with higher real interest rates should have lower PE ratios than countries with lower real interest rates.
· Countries with higher expected real growth should have higher PE ratios than countries with lower real growth.
· Countries that are viewed as riskier (and thus command higher risk premiums) should have lower PE ratios than safer countries
· Countries where companies are more efficient in their investments (and earn a higher return on these investments) should trade at higher PE ratios.


http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Comparing a Market’s PE ratio across time

Comparing a Market’s PE ratio across time

Analysts and market strategists often compare the PE ratio of a market to its historical average to make judgments about whether the market is under or over valued.

Thus, a market which is trading at a PE ratio which is much higher than its historical norms is often considered to be over valued, whereas one that is trading at a ratio lower is considered under valued.

While reversion to historic norms remains a very strong force in financial markets, we should be cautious about drawing too strong a conclusion from such comparisons. As the fundamentals (interest rates, risk premiums, expected growth and payout) change over
time, the PE ratio will also change. Other things remaining equal, for instance, we would expect the following.

· An increase in interest rates should result in a higher cost of equity for the market and a lower PE ratio.
· A greater willingness to take risk on the part of investors will result in a lower risk premium for equity and a higher PE ratio across all stocks.
· An increase in expected growth in earnings across firms will result in a higher PE ratio for the market.
· An increase in the return on equity at firms will result in a higher payout ratio for any given growth rate (g = (1- Payout ratio)ROE) and a higher PE ratio for all firms.

In other words, it is difficult to draw conclusions about PE ratios without looking at these fundamentals. A more appropriate comparison is therefore not between PE ratios across time, but between the actual PE ratio and the predicted PE ratio based upon fundamentals
existing at that time.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Brain drain and middle-income trap key issues

Brain drain and middle-income trap key issues

Tags: Attracting talent | Datuk Johan Raslan | Datuk Justin Leong | Datuk R Karunakaran | Dr Soh Chee Seng | GDP | Genting Group Malaysia | HSBC Bank Bhd | ISIS | Jon Addis | Malaysia | MICPA | Steven CM Wong | Talented people

Written by Loong Tse Min
Wednesday, 11 November 2009 11:39

KUALA LUMPUR: Malaysia needs to reach out to talented people wherever they come from, apart from bringing back its own, said Malaysian Institute of Certified Public Accountants (MICPA) vice-president Datuk Johan Raslan.

He said many Malaysians could be found working overseas as they were often adaptable, multi-lingual and inexpensive.

“The world wants Malaysians. We need to get them back, but we must not hold them back,” Johan said in the opening address of the two-day MICPA-Bursa Malaysia Business Forum 2009.

Cities such as Hong Kong, Singapore, London and Sydney were open to attracting talent and Malaysia needed to be equally so, he said.

“We should not shut out people with skills and expertise simply because they were not born here. We need to reach out to talented people wherever they come from,” he said.

Johan added that the country’s liberalisation measures put it “on the starting block” towards becoming a high-income economy and what was needed now were the fine details.

He also said the corporate sector must take ownership of abolishing corruption and not just consider it the responsibility of the government alone. “For every taker, there is a giver,” he said.

“In the final analysis, it is equally important to provide a conducive environment that is clean, fair and predictable, to attract companies to set up here, stay here and do business.”

Speaking in the first discussion session on Competing in the New Global Landscape, Institute of Strategic and International Studies (ISIS) Malaysia assistant director general Steven CM Wong, suggested that to become a high-value economy, the country should “get off protective industries”, “get rid of energy subsidies” and “get off the dependence on foreign workers”.

He said the potential disruption to business of some of his proposals such as the last one was really part of “transition costs”. Wong, whose research interests include international economics and international relations, also suggested that the Malaysian economy was too much consumption driven and there was a need to focus on production aspects.

Datuk R Karunakaran, a former director-general of the Malaysian Industrial Development Authority, who was moderating, pointed out that one key issue to higher salary was higher productivity. “With productivity comes better pay and better income,” he said.

In terms of composition of the economy for most developed countries, more than 60% of annual gross domestic product (GDP) came from the services sector, with Malaysia somewhere just over 50%. “That is a characteristic of a high-income economy and that is the transformation we will have to go through,” he said.

Deputy director in the Public-Private Partnership Centre and Secretariat to the Economic Council of the Economic Planning Unit Dr Soh Chee Seng said: “Our productivity levels are not really low, it is just that they are falling behind other rapidly developing countries like China, India, Indonesia and Thailand.”

He agreed that it was necessary for the country to be more open to attract the talent in the areas that it needed, “not just foreign talent but also Malaysians who are attracted elsewhere”.

HSBC Bank Bhd executive director Jon Addis said the diaspora of Malaysians was not a bad thing, as his home country Britain had benefited from a similar trend.

“If those skills and money return to Malaysia, that’s a good thing.”

He questioned whether foreign workers should be an issue and suggested that it might be a better strategy to raise the standard of education for Malaysians so that they could do the higher-value jobs while leaving the low-wage jobs to foreign labour.

He also said the country’s infrastructure was still “patchy” such as in terms of public transit, which had some idiosyncrasies.

Genting Group Malaysia’s head of strategic investments and corporate affairs Datuk Justin Leong said the Malaysian culture of adaptability and flexibility provided a good talent pool for businesses to expand overseas.

He said that from his experience, most Malaysians working overseas still held Malaysian passports and continued to have a lot of goodwill towards the country. Attracting them back was a possibility through sufficiently attractive job opportunities as well as improved safety and rule of law, he said.


This article appeared in The Edge Financial Daily, November 11, 2009.

Selangor to redevelop PJ, Klang, Kajang

Selangor to redevelop PJ, Klang, Kajang

Tags: Kajang | Klang | land value | Petaling Jaya | Petaling Jaya City Council | redevelopment | Section 13 | Selangor Government | Tan Sri Khalid Ibrahim

Written by Au Foong Yee
Tuesday, 10 November 2009 12:00

SHAH ALAM: Certain industrial and older housing enclaves in Petaling Jaya, Klang and Kajang have been identified for redevelopment in a bid by the Selangor government to enhance their land value and to create a stimulus for the state.

Selangor Menteri Besar Tan Sri Khalid Ibrahim said the regeneration exercise would kick off in PJ. Owners of buildings in “three or four” areas, among them Section 13, would be given incentives to redevelop their buildings for commercial use.

“We have written to the industries concerned to relocate. If they agree to move, they can rebuild on the existing tract of commercial property with certain densities,” Khalid told The Edge Financial Daily and theedgeproperty.com in an interview here yesterday.

These industrial operations would be allowed to be relocated to other more acceptable areas in Selangor, such as those near ports, Khalid said.

The redevelopment would be in the interest of the property owners, he added. “What we gain is that PJ will become redeveloped and vibrant. They [landowners] will make the money — the state is just making the environment conducive for them.”

Asked whether redevelopment would create traffic and transportation related issues,with congestion being at the top of the list, Khalid conceded, “In a way, yes.”

“We have to show them that we cannot leave PJ in this [current] manner; we have to convince them that we will plan for and provide facilities to reduce congestion,” he said.

Towards this end, the state government has asked for another transportation study to be carried out, based on increased densities in the areas concerned. This is to establish whether the higher densities are feasible. The concept of park-and-ride is also being considered.

According to a report earlier this year in City & Country, the property pullout of The Edge weekly , the 220-acre hub of industrial activity in Section 13 was now dotted with “limited commercial” developments in the form of modern offices and retail blocks.

Factories have been operating in Section 13 since the 1960s, but in recent years, the area's growing potential for commercial activities could not be ignored, given its strategic location. This explained the Petaling Jaya City Council’s approval for “limited commercial” activities there, based on certain guidelines.

Meanwhile, on the revival and rehabilitation of abandoned housing projects in Selangor, Khalid said they had been quite successful — thanks to land-value appreciation over time, resulting in people willing to pay more for the completed units.

The challenge, however, was in the selection of the best contractors or developers to complete the projects.

Some of the rehabilitation projects were initiated by the state government which was willing to lose “a bit” so long as the project was completed, added Khalid.


This article appeared in The Edge Financial Daily, Nov 10, 2009.

Plantation sector rating cut to neutral from overweight

http://www.theedgemalaysia.com/business-news/153204-PLANTATION%20[%3Cspan%20class-


Plantation sector rating cut to neutral from overweight

Tags: CPO price | Crude Oil | Genting Plantations Bhd | Indofood Agri-Resources Ltd | IOI Corp Bhd | Kuala Lumpur Kepong Bhd | Kulim (Malaysia) Bhd | neutral | plantation sector | Sarawak Oil Palms Bhd | TH Plantations Bhd | Wilmar International Ltd

Written by AmResearch
Monday, 09 November 2009 10:43

WE HAVE downgraded the PLANTATION [] sector from overweight to neutral. In addition, we have revised our recommendations on IOI CORPORATION BHD [] (IOI), KUALA LUMPUR KEPONG BHD [] (KLK), Wilmar International Ltd and Indofood Agri-Resources (IndoAgri) from buys to holds.


Earning estimates trimmed; fair values cut
Due to our lower average CPO price assumption for 2010F, we have revised earnings forecasts for companies under our coverage downwards by 4% to 11%, with the exception of SARAWAK OIL PALMS BHD [] (SOP). Despite this downward revision in our earnings estimates, EPS growth for FY10F will still be positive, driven by production growth and a low base effect in FY09F. Recall that earnings of bigger-caps like IOI and KLK in FY09F were affected by forex losses, provisions and lower manufacturing contribution resulting from writedowns.


CPO price assumption lowered to RM2,300/tonne
A result of our recent visits to companies under our coverage is that we are taking a more conservative stance on crude palm oil’s (CPO) pricing cycle — moving into 2010. We now expect prices of CPO to oscillate around RM2,300 per tonne — from our previous assumption of RM2,500/tonne. This implies that CPO prices are expected to remain somewhat flattish in 2010F.

Demand expansion may not keep pace with exceptionally strong supply growth from bumper harvests. We see demand and supply dynamics for CPO turning less favourable — pointing towards potential inventory imbalances — thus putting a cap on prices.

Supply concern is admittedly not new but this time around, we believe production will surprise on the upside due to: (1) A combination of expected normalisation in fresh fruit bunches (FFB) yields off depressed levels this year; and (2) Maturing acreage in 2010F. We reckon that FFB output could rise between 8% and 10% next year.

FFB production this year was affected by low yields resulting from poor fruit pollination and heavy rainfall. We think that palm oil inventory will range between 1.8 and two million tonnes next year — exerting downward pressure on CPO prices.

From January 2001 to September 2009, Malaysia’s average palm oil inventory was about 1.4 million tonnes per month. Average palm oil inventory for the past three years has been roughly 1.6 million tonnes/month while average stock usage was 1.3 times. We reckon that with a higher inventory level, stock usage could rise to 1.4 times to 1.5 times next year.

KLSE TRADE STATISTICS: LOCAL VS FOREIGN October 2009

http://spreadsheets.google.com/pub?key=txKJ-CJ_m_KD-Agbe6RtG5g&output=html

http://www.klse.com.my/website/bm/market_information/market_statistics/equities/downloads/trading_participation_investor2009.pdf


Observations:

The average price per unit volume of shares for the foreign institutions was MR 3.63; that for the local institution was MR 3.33.

The local retail investors were mostly into penny shares. The average value per unit volume traded was MR 0.66.

Half the volume of shares (49.96%) traded in October were generated by local retail investors.

Foreign Institutions were net buyers in October.

Local Institutions were net sellers in October.

No net change in value in trades of local retail investors. However, the volume of shares bought were higher than those sold.

The local retail investors were selling higher priced shares to buy into lower priced shares in October.

Based on value of shares traded, the Local Institutional funds were the biggest players in the local KLSE (43.69%).

Russian shares are cheap again

Russian shares are cheap again
Eastern Europe has witnessed momentous changes since the fall of the Berlin Wall 20 years ago.

By Elena Shaftan
Published: 5:54AM GMT 05 Nov 2009

In the two decades since this historic event, the lives of people in the former Communist Bloc have changed beyond recognition – changes that have increasingly attracted the attention of investors since stock exchanges started to open up in the region in the early to mid 1990s.

During this time, investors' focus has largely been on the opportunities presented by the convergence of Eastern European economies with those in the West.

Commodity shares to rise However, 20 years on from the symbolic collapse of the Wall and notwithstanding some setbacks, a lot of the "easy gains" have arguably been made from this story.

Having been through some difficult adjustments in the 1990s, most former Communist states are now members of the EU and share a common legal and regulatory framework with the West.

Living standards in the region have improved across the board as wages have risen and consumers have begun to discover credit. However, labour costs in many economies remain about a quarter of those in the West and taxes are a third lower than in Germany, ensuring the region remains an attractive destination for companies seeking to lower production costs.

Yet the development of these young democracies has hardly been uniform – some very clear winners and losers have emerged and it is worth casting a fresh eye over the new opportunities ahead of us.

Followers of the region will be all too aware that some of the smaller countries in the Baltics and Balkans got carried away with borrowing their way to growth, resulting in much publicised economic imbalances. However, the situation in economies such as Poland, Turkey, Russia and the Czech Republic couldn't be more different and this is where I believe the greatest prospects now lie.

These countries are benefiting from an improving economic outlook. They have substantial and still under-developed domestic markets and, with consumer debt levels of only 10pc to 30pc of gross domestic product (GDP) - versus 100pc for the UK - offer superior growth prospects than their less-fortunate neighbours.

In Poland for example, economic growth was 1.1pc in the second quarter, having remained positive even during the depths of the financial and economic crisis. Poland has benefited from relatively low exposure to exports but its solid performance has also been underpinned by structural factors.

While many other emerging economies thrived in 2001-2002, Poland struggled as unemployment and interest rates hit 20pc. Now they are just 11pc and 3.5pc respectively and the economy is benefiting from the unleashing of substantial pent-up demand.

This, together with a far smaller debt burden than in many other European countries, has allowed consumers to continue spending and support the economy.

Poland and the Czech Republic are also net beneficiaries of EU funding that aims to improve infrastructure. In Poland for example these transfers are worth around 3pc of GDP per annum for the next four years and are set to boost investment and construction.

Turkey offers further opportunities. While the Turkish economy suffered a sharp contraction last winter, it rebounded rapidly with 12pc quarter on quarter growth between April and July.

A positive side effect of the crisis has been the taming of inflation which has been above 20pc for 25 of the past 30 years, but is now down to a historic low of 5.3pc. This has allowed the central bank to slash interest rates from almost 17pc a year ago to an all time low of 6.75pc.

Lower interest rates should feed through to loan growth and stimulate the economy. Signs of recovery are already emerging with home sales rising 72pc year on year in the second quarter, while seasonally-adjusted automobile sales in September are at record levels.

The Russian economy has also stabilised now that the financing constraints that held back businesses over the winter have eased. After a sharp sell off last year, shares in Russian oil and gas companies now appear cheap compared to historical norms and their international peers.

While the events of 2008 have demonstrated that commodity prices can fluctuate in the short term, the development of China and India provides a structural source of incremental demand that is likely to exert upward pressure on prices over time.

But Russia is not just about oil. It is a country of 140m people – a huge consumer market, with a growing middle class aspiring to raise living standards.

Consumption patterns are changing as a result. Russians still drink on average around eight times more vodka than Britons, yet over the past decade, consumption of beer and fruit juices have leapt from next to nothing to near European levels.


Similar trends are emerging for other goods such as yoghurts, mineral water, vitamins, computers, broadband and banking services. These trends are likely to develop over time, benefiting the strongest local companies.

There are other reasons why we like these markets. First, their stock markets are large and liquid compared to others in the region, making them a more attractive destination for international investors, even though they carry more risk and experience greater volatility than Western counterparts.

Second, they often have very different dynamics, so investors can diversify while making the most of any economic and financial recovery.

Russia, for example, is the world's largest oil exporter, while Turkey imports most of the oil that it consumes. Investing in both means fund managers can take advantage of not only rising but also falling energy prices.

The Polish economy is driven primarily by domestic demand, which helped it to grow even when the rest of Europe was contracting in the first half of 2009. Czech equity markets, meanwhile, contain several solid defensive stocks that tend to be less susceptible to difficult economic conditions.

While stocks listed in the 'big four' markets of eastern Europe are most important for us at present, our ability to invest in the broader region means we can discover some hidden gems in smaller regional markets from time to time.

The ability to invest in a wide range of markets - including for example Israel and Croatia, and former Soviet republics such as Kazakhstan and Georgia - has given us the flexibility to adapt to different market conditions.

We are also exploring opportunities among West European companies with successful operations in Eastern Europe, further broadening the investment horizon.

The Eastern Europe of today is a very different place to that of 20 years ago. There have been economic winners and sadly, some losers. However, the opportunities for investors to profit from the region's success stories are clearer than ever.

Elena Shaftan is the fund manager of Jupiter Emerging European Opportunities Fund

http://www.telegraph.co.uk/finance/personalfinance/investing/6501437/Russian-shares-are-cheap-again.html

The great natural gas conundrum

The great natural gas conundrum
Nebulous, drifting, volatile: all good ways to describe both natural gas and the conflicted outlook for the commodity among industry experts at the moment.

By Rowena Mason
Published: 9:38PM GMT 08 Nov 2009

A gas field exploration platform owned by China National Offshore Oil Corporation (CNOOC) in South China Sea.

On the one hand, a growing number of economists are the early-bird canaries in the mine, warning of a dangerous build up of natural gas on the verge of suffocating the market with an oversupply. On the other side, there is no shortage of energy companies dashing into the biggest gas extraction projects the world has ever known, proclaiming that a new era of burgeoning demand will be upon us.

So what has caused the commentators to float apart to such a degree? And whose sums look set to turn out to be an expensive mistake?

First, a look through the hazy clouds of forecasting at the fundamentals of the gas market. Henry Hub prices at the New York Mercantile Exchange have crashed 62pc this year. Reserves in the US are at historic highs. In fact, there's a glut of the stuff packed into disused fields and liquefied natural gas storage units across the globe. For many months now, producers have been hopefully waiting for gas prices to follow the oil price upwards, but the traditional connection – with a time lag between gas trailing oil – appears to have drifted out of kilter.

Part of this is the recession: Royal Dutch Shell, Europe's biggest energy company, warned two weeks ago that it had seen absolutely no increase in need for gas in Europe, and only a slight upturn in the US. In the short term, there has even been talk among Morgan Stanley analysts that the natural state of contango – where spot prices are lower than forward prices – could collapse causing the entire gas market to seize up next year.

Now the International Energy Agency is expected to warn this week that there is little chance of a recovery in demand before 2015, fuelled by a global drive to decarbonise with a new emphasis on renewable sources, nuclear power and energy efficiency.

But looking beyond the stagnant demand, oversupply has also been caused by technological breakthroughs in extraction techniques that mean so-called "tight" formations are getting cheaper to develop. The US was at one point speeding its way through natural gas reserves at an alarming rate, but over the past two decades, unconventional gas–from shales and coal-bed methane –has grown from 10pc to 40pc of the market.

Some commentators, including the Pulitzer Prize winning author of Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power, have hailed this as a revolution in the fossil fuel industry that could change the world's whole gas balance if other countries follow America's lead. Technology has also given greater competition to the markets.

So why, if gas has become suddenly abundant, mobile and unwanted, are there still energy majors from BP to Shell to ExxonMobil keen to exploit expensive developments in far-flung, often hostile corners of the globe from Iraq to Russia's Yamal peninsula reserves?

The energy world still appears desperate to develop major gas developments like never before – the biggest being the massive Gorgon fields in Australia, where the energy giants have already signed multi-billion dollar contracts to supply China and India for decades to come. Frank Chapman, the chief executive of BG Group, even claims we will need "a Gorgon a year for the next 10 years" to meet ballooning global needs. Meanwhile, ExxonMobil, looking ahead, predicts that demand for gas in the West alone will grow by 2pc a year, or 30pc by 2030.

Part of the optimism is likely to be political: although countries are desperate to reduce emissions from fossil fuels, gas releases only half the carbon dioxide of coal when burned and is a much cheaper option than developing renewables. As the world also eventually weans itself off petrol and other oil-based products for transportation, electricity demand is set to double or triple.

One day in decades to come, cars and other modes of transport may all either be powered directly by natural gas or electricity generated by gas-powered and renewable power stations. Seizing on this opportunity, Tony Hayward, chief executive of BP, has recently been taking every chance to trumpet the potential of gas as the primary fuel of the medium-term future.

Some even believe the revolution in unconventional gas supplies will be unable to keep pace with this impending thirst for the commodity. Ofgem, the energy regulator, has taken forecast "tight" gas production into its estimates, but remains deeply concerned about the availability of gas in Europe over the next decade.

With all these shifting factors, one thing is for certain. Gas isn't behaving like ever before. And its future as a commodity is entirely interwoven with political decisions – highly unpredictable ones – about its reliability as a replacement for coal and oil.

http://www.telegraph.co.uk/finance/markets/6526528/Future-of-gas-linked-with-political-decisions.html

Diary of a Private Investor

Diary of a Private Investor: My aggressive investment strategy has backfired
By the beginning of this month, my portfolio had felt the full, unhindered power of the setback and fallen close to 10pc.

By James Bartholomew
Published: 6:49AM GMT 04 Nov 2009

I have to admit I jumped the gun.

As we were getting towards the end of October without suffering any significant setback in the stock market, I thought, "Hurrah! We have survived the most dangerous month of the year and now we have the run up to Christmas and beyond which usually is pretty good for shares."


Related Articles
Commodity shares are heading up So, thinking I would get ahead of the crowd, I put remaining cash into shares. I sold my Japanese yen bonds and put these into shares, too. What happened?

The October setback arrived late. My portfolio fell more than the market generally because I have been favouring what you could call "aggressive recovery plays".

I subscribed to the rights issue of Barratts, the house builder, and bought some extra shares into the bargain. I reckoned the price had been depressed by the rights issue and would rise when all the money was secured. I bought at 153p, only to see the shares fall back even further – to 122p.

I bought more Enterprise Inns, the pub owner, too, paying 139.9p. The shares had jumped 20p after the Office for Fair Trading said it has not found evidence that companies such as Enterprise Inns, which require their tenants to buy their beer, are reducing competition in a way that damages consumers.

This removed one of a little pile of concerns that has been weighing down the shares. I was hoping that as these various concerns were dealt with or found not to be quite so bad as feared that the price would float nearer to its net asset value. Instead, the shares fell more than most and traded around 118p this week.

I also recently bought a few shares in Indo-China Capital Vietnam Holdings at US$4.54. I like Vietnam, but did not quite realise when buying that the company seems to be winding itself down.

I also bought a few Real Estate Investors, a small property company, at 4.96p. I had noticed some director buying and, on looking into the detail, liked the look of it.

Finally, I bought a small holding Chaoda Modern Agriculture, an agribusiness quoted in Hong Kong. Chaoda grows vegetables, fruit and tea and sells to supermarkets and abroad. I bought at HK$6.33.

So I bought up to the hilt. All my cash was gone and most of my bonds, making me 95pc invested in shares or even more if you count my mortgage as financing my shares which is about right. Thus, by the beginning of this month, my portfolio had felt the full, unhindered power of the setback and fallen close to 10pc.

I can't give a precise figure because my curiosity about exact changes in my portfolio's value dwindles when I am losing money.

And this is without counting my shares in Aero Inventory, which have been suspended, as I write, because the company had a problem with valuing, ahem, its inventory.

What now? I still believe November to Christmas and beyond is generally good for shares. David Schwartz, who looks at stock market statistics, has said there has not been much evidence of a seasonal trend this millennium.

It is possible something has changed or that the trend has become self-defeating as people try to get ahead of it. But, even on recent figures, shares have risen in more than half the November-to-March periods. I think there is some unknown force that tries to sustain the market. And I still think some of my shares are excellent value.

In the case of Barratt, I am encouraged by recent experiences of the property market. I am an executor of my uncle's estate. We put his house on the market and within three days agents had taken 42 people to it and we had an offer at the asking price. I am also an executor of another estate, where three potential buyers were vying for the house.

As for the stock market, the Bank of England has decided to do another £50bn of quantitative easing. I think and hope this should help keep shares out of trouble for a while at least.

http://www.telegraph.co.uk/finance/personalfinance/investing/6498737/Diary-of-a-Private-Investor-My-aggressive-investment-strategy-has-backfired.html

Gold: how high can the price go?

Gold has reached an all-time high, breaking through the $1,100 an ounce barrier on a weaker US dollar and the continued appetite from investors for the precious metal's safe-haven attributes.

Published: 2:51PM GMT 10 Nov 2009

Demand continues to be strong – even Harrods, the famous Knightsbridge store, is getting in on the act by selling gold bars and coins to its upmarket customers.

Gold has returned more than 20pc over the past year but the question remains: how high can the price of gold go?

Here are the thoughts of analysts taken from around the globe.

Suki Cooper, commodities analyst, Barclays Capital
Ms Cooper said: “We expect prices to maintain their upward momentum through to at least the first half of 2010, where we expect prices to average $1,140 in the second quarter. The unexpected purchase of gold by the Reserve Bank of India has only added to the positive sentiment towards gold. Even though gold's attributes have not changed, we have seen a change in attitude from investors towards gold. From the official sector through to retail investors, there has been a structural shift in the demand side.”

Jim Rogers, chairman of Singapore-based Rogers Holdings
Mr Rogers argues that gold hasn't begun to peak, adding that it will climb from a nominal record near $1,100 an ounce to $2,000 an ounce in the future. He said: “Just to get back to the old high back in 1980, adjusted for inflation, the price would need to be over $2,000 now. So we’ll certainly get there some time in the next decade.”

London Bullion Market Association
A poll of about 370 delegates at the London Bullion Market Association's annual conference predicted that gold would be at $1,181 in 12 months' time. The poll covered 368 traders, analysts, miners and central bankers.

Ellison Chu, Standard Bank Asia
The Hong Kong based manager of precious metals at the bank expects the price of gold to maintain four-figure levels given the strong demand, particularly from Asia.

"India's purchase [India’s central bank recently bought 200 tonnes of gold] had a psychological impact on investors. They think other central banks will also buy gold for their reserves. Gold will probably hang on to these high levels. We're seeing good seasonal demand ahead of Christmas and the Chinese New Year."

Nouriel Roubini, professor of economics at New York University’s Stern School of Business
In an interview with Hard Assets Investor, Mr Roubini said there were only two scenarios that would see gold go much higher: inflation and Armageddon.

“We don’t have Armageddon, we don’t have inflation, so gold can maybe go slightly higher. But those people who delude themselves that gold can go to $1,500 or $2,000 are just talking nonsense. The fundamentals are not justified, and those people are just talking their books.”

David Levenstein, investment adviser
Writing on Mineweb, David Levenstein, a veteran of 29 years in futures, equities, forex and bullion, said gold appeared to be on course for a shift to $1,300 because of the gloomy outlook for the dollar.

"Frankly, I cannot see any bit of news that may suddenly appear that could have a miraculously powerful effect on the value of the dollar," he wrote. "While my experience has taught me that it is very difficult to predict future prices, all the empirical evidence tends to indicate that we can expect much higher prices for gold."

Bill Downey, investor and price analyst
“Cycles suggest we are nearing a pullback. We have arrived at a key resistance area at a time when key cycles are due. We're modifying key resistance to $1,105-$1,110 followed by $1,132-$1,150. The potential for a high to be established this week and an autumn correction unfolding thereafter has grown significantly. We want to see at least a bit of price weakness first ... but longs [those who hold gold] should be cautious.”

http://www.telegraph.co.uk/finance/personalfinance/investing/gold/6537637/Gold-how-high-can-the-price-go.html

Tip Sheet: Valuing a Business

http://www.coopscanada.coop/public_html/assets/firefly/files/files/Business_SuccessionPDFs/Tip_Sheet_Valuing_a_Business_REV.pdf

****Determining the value of a business is one of the most difficult aspects of any transaction

VALUING THE BUSINESS

Introduction

After deciding to buy or sell a business, the subject of "how much" becomes important. Determining the value of a business is one of the most difficult aspects of any transaction, since every business is unique.

A common misconception is that valuation is an exact science. While the use of formulas in a valuation implies exactness, it is very difficult to set the worth of a company at a single figure. To establish a fair market value, "hard" figures, such as assets, liabilities, and historical earnings and cash flow are used. But "soft," or subjective, figures, such as projected earnings, future cash flow, and the value of intangibles (e.g., patents, know-how, the quality of management, and leases at below-market rates) are also used. Soft figures also include such considerations as current market conditions, industry popularity, and, most important, the objectives of the seller or buyer. With all this subjectivity, fair market value can be, at best, only a range of estimates.

A second misconception is that value equals selling price. The final selling price can be either higher or lower than the estimated range of values for the company, depending on the eagerness of the buyer to buy and the seller to sell, the demand for the type of company, the
form of consideration paid, the negotiating skills of the parties, etc. In fact, the selling price of a company sometimes does not seem to have much relation to its estimated value.

Ask appraisers the value of your business and they will respond, "What's the purpose of the valuation?" Valuation methods -- and therefore values -- vary depending on the reason for the valuation. Different techniques can be used to arrive at different values, and each of the values may be correct for a specific situation. For purposes of this discussion, we will focus on the valuation techniques used for buying or selling a company as a going concern. Whichever technique is used, the valuation comprises these key elements: 

• gathering information about the company and the industry;
• recasting the historical financial statements;
• preparing prospective financial statements;
• comparing the company's results with those of other companies in the industry; and,
• finally, applying appropriate valuation methodologies.

Gathering Information

The selling memorandum, the basis for the buyers preliminary examination of the company, should contain comprehensive information about the company, its history and operations, and its market position. As a buyer, you will continue gathering all the information you can about the company through such sources as management interviews and conversations with the company's vendors and customers.
You will also want to gather similar information about competitors of similar size. In addition, you may want general information about the industry and the industry's leaders to help you understand market trends, competitive strategies, and the dynamics that cause companies in this particular industry to grow and succeed. Potential sources for industry and competitor information include market studies, reports of trade associations and credit rating agencies, and annual reports and stock analysts' reports of publicly owned companies.

Recasting Financial Statements

The historical financial statements may need to be adjusted to make them more meaningful or to compare them with those of the company's competitors. For example, take the financial statements of a closely held or family business whose objective in years past has been to minimize earnings in order to minimize corporate income taxes. To achieve this, the company may have awarded unusually large bonuses to employee-owners, masking the "true" earning power of the company. As the buyer or seller, you would want to recast, or normalize, the financial statements to account for this type of activity. In valuing a business, some typical income statement adjustments may include the following:

· Excessive management salaries.
· Salaries paid to individuals who can be replaced at much lower salaries.
· Retirement and health plans that provide better benefits than the plans of other companies in the industry.
· Excessive perquisites, such as company cars and club memberships.
· Favorable or unfavorable leases.
· Last-in-first-out (LIFO) inventory adjustments.
· Interest rates if the buyer borrows at significantly different rates.
· Adjustment of sales to reflect selling price increases, in cases where prices have not been increased recently and such increases would not have affected sales levels.
· Nonrecurring expenses, such as legal expenditures, relocation costs, and casualty losses.
· Accelerated depreciation charges, utilized to reduce taxable income.
· "Window dressing," or practices that temporarily improve current earnings. For instance, a company might reduce necessary long-term investments, such as research, advertising, or maintenance, improving its current earnings but weakening its potential for future earnings.
· Tax rates. If the company has an unusual tax situation, e.g., available net operating loss (NOL) carry forwards, an adjustment should be made to reflect "normal" taxation.

In valuing a business, some typical balance sheet adjustments may include the following:
· LIFO reserves, to adjust the inventory to current cost.
· Undervalued or overvalued marketable securities and investments in unconsolidated subsidiaries.
· Fixed assets that have appreciated in value.
· Intangible assets that may not be recorded on the books.
· Beneficial leases.
· Assumable debt with favorable interest rates or repayment terms.
· Unrecorded pension and other postretirement liabilities.
· Contingent liabilities.

After identifying and quantifying applicable adjustments, you will have a more meaningful set of financial statements to use to make financial projections and to compare the company's performance with that of other companies.


Projecting Earnings

Prospective financial information should be prepared for the next three to five years. If you are the seller, you probably have already prepared this information for your own purposes and included portions of it in the selling memorandum. If you are the buyer, however, chances are that you will want to do your own analysis. Prospective earnings may be estimated in one of three ways:

1. Use an average annual growth rate derived from the past three to five years' income as an estimate of future annual earnings. This method assumes that the earnings trend will remain essentially unchanged and, therefore, that historical earnings are a valid indicator
of future performance. The major disadvantage of using average historical growth rates is that past conditions may not remain the same in the future. Because business conditions are constantly changing, you should adjust for known and anticipated changes.

2. Use an estimate of future earnings under the current owners' management, adjusting for inflation and industry trends. This method of defining future earnings assumes that, after the sale, management will continue to operate the company in the same manner as past
management and with the same degree of success.

3. Use an estimate of future earnings under the new owners' management, adjusting for inflation and industry trends. This method is probably most useful to the buyer. It analyzes the effect that new management or strategies will have on future earnings. These effects include changes in marketing strategy, manufacturing technology, and management philosophy.


Comparisons with the Industry

Before proceeding to the valuation, the company's results, as restated, should be compared with the results of other companies in the industry and with the industry in general. Some of the comparative analysis should focus on the following figures:
· Sales growth.
· Gross margin.
· Earnings before income taxes, as a percentage of sales.
· Earnings before interest and income taxes, as a percentage of sales (this eliminates the financing bias)
· Earnings before depreciation, interest, and income tax, as a percentage of sales (this eliminates the historical cost bias as well as the financing bias).
· Return on equity
· Return on assets.
· Current ratio.
· Receivables and inventory turnover rates.
· Debt to net worth ratio
· Interest coverage.

Does the company under perform or outperform similar companies and the industry averages?
What is its growth rate relative to the industries?
Is it gaining or losing market share?

This analysis will give you some idea of whether the company deserves a premium or discount over the value of comparable companies. Wide fluctuations from the industry averages should be explained because they may indicate errors in the underlying data.


Valuation Method

The valuation method you select will be determined by your objectives for the valuation. As the seller, the objective is fairly clear -- to get the most for the company. As the buyer, however, your objective may not be as straightforward. It is important that you understand what you are buying and why you are buying it. The price you pay for an ongoing business may be quite different from the price you pay for a business that you intend to cannibalize for certain product lines or markets. For each purchase, a different valuation method may be appropriate.

Three approaches are commonly used in valuing a closely held business.

• The first approach uses the balance sheet to arrive at the fair value of net assets;
• the second examines market comparables; and
• the third analyzes the future income or potential cash flow of the company.

Combinations of these approaches may be used as well.


Balance Sheet Methods

Balance sheet methods of valuation are based on the concept that a buyer basically purchases the net assets of the company. Book value is probably the easiest method to apply. Using the company's financial statements, book value is simply calculated by subtracting total liabilities from total assets. The advantage of this method is that the numbers are usually readily available. Its drawbacks are numerous,
however. Book value does not reflect the fair market value of assets and liabilities; it expresses historical value only and is significantly affected by the company's accounting practices. It may not record, or may significantly undervalue, intangible assets such as patents and trademarks.

Lastly, book value ignores earnings potential. Despite these drawbacks, book value can be a useful point of reference when considering asset valuation.

Adjusted book value is simply the book value adjusted for major differences between the stated book value and the fair market value of the company's assets and liabilities. A refinement of book value, adjusted book value more accurately represents the value of a company's assets, but still has many of the same drawbacks.

One of the most significant typical balance sheet adjustments is the adjustment of the value of a company's intangible assets. This is also one of the most difficult. What is the value of an "ongoing" business? If a company has patents, trademarks, copyrights, or a proprietary
manufacturing process, how much are they worth? How much would it cost to develop similar processes, and could legal action result if the developed process were found to be too similar to a competitor's? What is the value of a company's existing customer base, long-term contracts, or exclusive license agreements? If you started a similar company tomorrow, how many months of losses would you have to incur before sales would reach profitable levels? Such questions make balance sheet methods a less effective measurement of business values for ongoing companies.

Despite these shortcomings, balance sheet methods have an appropriate place. For companies that are dependent on income-producing assets, such as real estate companies, banks, or leasing companies, balance sheet methods may provide the most reasonable valuation.

A less used balance sheet method is liquidation value. Liquidation value estimates the cash remaining after the company has sold all its assets and paid off all its liabilities. This method assumes that a bulk sale takes place, and therefore many of the prices you would get for the assets are lower than "fair market value." The liquidation may be orderly or forced, depending on the circumstances. In practice, only a business that is in severe financial difficulty or one that must be sold quickly (e.g., the owner has an immediate need for cash or a government order to sell has been issued) can be purchased at liquidation value. However, it is important to know this value during your negotiations. Financial institutions commonly use this method to determine the value of assets used as collateral to secure financing.

In applying any of the balance sheet methods, be alert to unrecorded liabilities that affect net asset value, such as noncancelable leases (if you intend to move), severance costs (if you are considering layoffs), or unfunded pension liabilities and other retiree benefits.


Market Comparables

This method determines a company's value by comparing the company with a similar public company or with recently sold similar businesses. While quite common in real estate transactions, this method is difficult to apply to most businesses because of the difficulty of
finding comparable businesses or transactions.

When suitable companies can be found, the price-earnings ratio of the comparable company (its stock price divided by its after-tax earnings per share) is typically used to determine value. Thus, if the stock of a comparable business trades in the public market at a price-earnings ratio of 12, the value of the candidate can be assumed to be 12 times its earnings.

Even if comparable companies can be found, this method is difficult to implement. Public companies are often engaged in diversified practices so that the price-earnings ratios may not be relevant. And since the companies are not identical, you must also consider whether your company should command a premium or discount. Possible price adjustments include the following:

· A premium for having anticipated earnings growth greater than expected industry norms.
· A discount for the additional risk of not enjoying the same liquidity as publicly traded stock. This adjustment could reduce the value by as much as30 to 50 percent for lack of marketability.
· A premium for acquiring control. If you want to acquire a controlling interest, you may need to pay a hefty premium to encourage other stockholders to sell their interest. This occurs frequently in both hostile and friendly takeovers. The premium can be quite substantial (40 to 50percent).
· Small Company discount. If your company is smaller than the average company in your industry, expect the buyer to use a price multiple for your company that is lower than the price multiples applicable to the market leader and other companies in your industry. This adjustment could reduce the value by as much as 30 percent. Despite these shortcomings, market comparables are very useful as reference points from which to value your company.


Earnings Methods

Various approaches are used to value future earnings power. Three of the more common approaches are capitalized earnings, discounted future earnings, and discounted cash flow. Capitalized earnings can be quickly computed and are often used to make preliminary estimates of value. They are calculated based on annual after-tax income. In using this method for valuing a company, you first determine your desired rate of return. The initial investment or value is then computed by dividing the average after-tax earnings by the desired rate of return. The major disadvantage of this method is that it does not take into account the time value of money. In addition, it assumes that the most recent earnings are a valid indicator of future performance.

VALCO, Inc.: Capitalized Earnings Method of Valuation
(Dollar amounts in thousands)
Assumptions:

After-tax income for the most recent year $750
Desired rate of return on investment 15%
Calculation of capitalized earnings:
Divide Income by rate of return
$750/.15=$5,000

The discounted future earnings method initially requires an estimate of after-tax income for future years (generally five to ten years), an estimate of value at the end of this future period ("residual value"), and the investor's desired rate of return. Each year's income and the residual value are then discounted (the process of dividing sums to be received in the future by an assumed earnings rate) by the desired rate of return. The sum of these discounted values is the estimated value (present value) of the company.

The inherent advantage of the discounted future earnings approach is that future earnings potential becomes the investment criterion, taking into account the time value of money.

Disadvantages include the fact that, like any estimate, future earnings cannot be projected with certainty. Residual value, which may be affected by industry and economic uncertainties, the buyer's intent, and other factors, is also difficult to project. Finally, it may not be possible to reinvest all earnings because of practical limitations imposed by the business environment and because earnings do not necessarily take the form of cash.

The first two disadvantages can be overcome to some extent by using computing models based on optimistic, pessimistic, and most-likely outcomes for future earnings and residual value. The last disadvantage can be overcome by using the discounted cash flow method. This method is essentially the same as the discounted future earnings method, except that cash flow rather than income is projected for each future year. Many consider this method the best for determining value. In many cases cash flow is a more important consideration than profits, as in the case of a heavily leveraged transaction.


Determining the Final Value

The buyer and seller will each conduct their own analysis to estimate the future earnings and cash flows and assess their own risk tolerance in order to estimate the company's value. For example, the buyer may feel this is a moderately risky opportunity requiring a 15 percent aftertax return to compete with other available investment opportunities. As the perceived risk increases, so does the discount rate, which reduces the current value of the company. The seller, on the other hand, may determine that his or her next best investment opportunity will yield a maximum after-tax return of 10 percent, and he or she will require a similar discount to sell this business. In valuing the business, the buyer's and seller's results can be significantly different.

The parties should not spend much time arguing about the mechanics of how they arrived at their valuations other than to understand the assumptions and techniques used. Since they each have different views on risk, growth, etc., there is little point in trying to agree on "value."

Use your value as a guide for developing your negotiating strategy. As the buyer, your value will be the maximum price that makes sense taking into account the perceived riskiness of the transaction and the funding available to you. As the seller, your value will be the minimum you are willing to accept considering your alternative uses for the funds from the sale.

For more resources to Start or Grow Small Business, visit our website at http://www.womensenterprise.ca/ or call 1.800.643.7014

 

http://www.womensenterprise.ca/resources/downloads/valuing-business.pdf

Wood Market on Path to Recovery

http://myinvestingnotes.blogspot.com/2009/11/wood-market-picks-up-speed-in-vietnam.html

In May 2009, the U.S. economy also showed signs of recovery, and the housing market warmed up. Encouraging signals also emerged in Japan and Europe in July and August 2009. Therefore, Vietnam’s export revenue has fared better and posted month-on-month increase since May. At present, wood processing enterprises have received many orders. These indicate that Vietnam’s wood processing sector is on the path to recovery.

VALUING TECHNOLOGY BUSINESSES

One of the most important questions for any business owner is “What’s my business worth?” to which, the stock answer is “It depends.” This paper explains the factors affecting the valuation of a business. This is useful not only when selling a company, but also when bringing in new investors who buy a piece of the company.

Valuation thoughts and concepts

The fundamentals underlying the valuation of a business are no different than those for other things we buy and sell such are houses, cars, old furniture, etc.

Value is:

- Based on perception: “Beauty is in the eye of the beholder.” A house that one person perceives needs a lot of work is a “fixer upper” to someone else who sees an opportunity to turn his sweat into profit. The same exists for businesses.

- Personal: “What is it worth to me.” A 1957 Chevy has more value to someone for whom this brings back fond memories than to someone who sees an old car with a rough engine and no air conditioning. A business is worth more to someone who has successfully run similar enterprises.

- Relative: “Different values for different people”. Closing a sale (both parties agreeing to a value) is as much an art as a science. It is a matter of both parties seeing benefit in making the deal.

Read on:
http://www.corp21.com/Valuation.pdf

Valuing uncertainty

Valuing uncertainty

Author: Andrew Kent on 26 February 2009

A key issue with business valuations is the level of certainty that can be placed on future earnings. The optimistic seller wants potential growth factored into the numbers, while the pessimistic buyer would like to exclude anything that customers are not contractually committed to. With this in mind one may wonder how any transactions occur at all. Fortunately not all sellers are optimistic and not all buyers are pessimistic; indeed when the sellers are pessimistic and the buyers are optimistic, both walk away happy with the deal.

However the majority of business sales involve people who basically want a fair deal - they might fear being ripped off, they might hope for a great deal, but they generally expect a fair deal.

The issue that makes both sides feel uncomfortable is determining what a genuinely fair deal is. The underlying problem is that what is being sold is the future of the business, not its past. As the future is uncertain, so is the value of the business.

To this end, a source of comfort becomes what other people have paid for similar businesses. This can be found at http://www.valuemybusiness.com.au/  and can also be obtained from advisers and brokers that specialise in specific industries.

What many business owners find difficult to understand is why the sale value and the book value of the business are not the same thing. The fact is that these have never been the same.

Historically the difference in value has been catered for by adding a figure for goodwill if the sale price is higher than the book value. Alternately, if the sale price is lower than the book value, then the asset values are adjusted down through write-offs.

The reason that the sale value and the book value are different is because the book value is based on the businesses past, while the sale value is based on the businesses future.

In today's market, there is a strong move away from discussions of goodwill and asset prices to a focus on EBIT and EBIT multiples. A key reason for this is that the asset structure of most businesses has fundamentally changed from owning property, plant and equipment to leasing it.

As a result many businesses have ongoing liabilities that exceed their debtors and forward orders. This is not because a business is in bad shape, but rather a reflection of the timeframe for the lease commitment exceeds the timeframes for sales commitments.

So the key discussion point and negotiating point will be around the sale forecast.

Anyone in business today knows that the horizon of certainty on a sales forecast is shorter than it has ever been, so what value will you place on what is beyond the horizon?


http://www.smartcompany.com.au/selling-your-business/valuing-uncertainty.html

3 Business Valuation Methods

3 Business Valuation Methods
How to Determine What Your Business Is Worth

By Susan Ward, About.com



Definition Valuation
How much your business is worth depends on many factors, from the current state of the economy through your business’s balance sheet.

Let me say up front that I do not believe that business owners should do their own business valuation. This is too much like asking a mother how talented her child is. Neither the business owner nor the mother has the necessary distance to step back and answer the question objectively.

So to ensure that you set and get the best price when you're selling a business, I recommend getting a business valuation done by a professional, such as a Chartered Business Valuator (CBV). In Canada, you can find Business Valuators through the yellow pages or through the website of the Canadian Institute of Chartered Business Valuators.

A Business Valuator (or anyone valuating your business) will use a variety of business valuation methods to determine a fair price for your business, such as:

1) Asset-based approaches
Basically these business valuation methods total up all the investments in the business. Asset-based business valuations can be done on a going concern or on a liquidation basis.

•A going concern asset-based approach lists the business net balance sheet value of its assets and subtracts the value of its liabilities.
•A liquidation asset-based approach determines the net cash that would be received if all assets were sold and liabilities paid off.

2) Earning value approaches
These business valuation methods are predicated on the idea that a business's true value lies in its ability to produce wealth in the future. The most common earning value approach is Capitalizing Past Earning.

With this approach, a valuator determines an expected level of cash flow for the company using a company's record of past earnings, normalizes them for unusual revenue or expenses, and multiplies the expected normalized cash flows by a capitalization factor. The capitalization factor is a reflection of what rate of return a reasonable purchaser would expect on the investment, as well as a measure of the risk that the expected earnings will not be achieved.

Discounted Future Earnings is another earning value approach to business valuation where instead of an average of past earnings, an average of the trend of predicted future earnings is used and divided by the capitalization factor.

What might such capitalization rates be? In a Management Issues paper discussing "How Much Is Your Business Worth?", Grant Thornton LLP suggests:

“Well established businesses with a history of strong earnings and good market share might often trade with a capitalization rate of, say 12% to 20%. Unproven businesses in a fluctuating and volatile market tend to trade at much higher capitalization rates, say 25% to 50%.”

3) Market value approaches
Market value approaches to business valuation attempt to establish the value of your business by comparing your business to similar businesses that have recently sold. Obviously, this method is only going to work well if there are a sufficient number of similar businesses to compare.

Although the Earning Value Approach is the most popular business valuation method, for most businesses, some combination of business valuation methods will be the fairest way to set a selling price.


http://sbinfocanada.about.com/od/sellingabusiness/a/bizvaluation.htm