How is a business valued
3 ways to value a company - MoneyWeek Investment Tutorials
welcome to this week's money week video
and this week I want to deal with a
topic that's a few people have asked
about it's a pretty big meaty topic it
is how do you value a company now
obviously that's something that
Predators want to do before they take
over a target to use take over language
and it's something that investors should
have an interesting when you're buying a
share you want to be looking at you know
am I getting good value for money or not
and how do I think about the value of
the company well to cut to the chase how
do you think about the value of any
asset take a house for example arguably
there are three ways you can decide
whether or not to buy a property you
could do a sort of bottom-up estimation
of what it would cost by the land and
build the thing that will give you a
number okay you could look at the price
of houses nearby they won't be identical
but that will give you some feel for the
one you're looking at or you could say
actually maybe a property is only worth
what someone's prepared to pay to live
in it so you could sort of do a
calculation of all the future rent that
the asset might generate and then bring
it back into today's money terms using a
technique I've covered in another video
called discounting all right
Caesar called bottom-up
bricks-and-mortar approach the house
next door approach and the value from a
rental perspective approach now those
won't all necessarily give you the same
number they'll give you a range okay and
then it's the buyer you negotiate the
lowest price possible as a seller you'll
to negotiate the highest price possible
well what's that got to do with today's
topic companies can be valued using a
sort of similar three-pronged approach
if you like so in this video all I'm
going to do is outline those three
approaches and then maybe in future
videos if there's demand out there I can
take that on a stage further so how do
you do it right well fundamentally it's
an art rather than a science
all right there are numbers involved at
the end of the day a company like a
house is only worth what someone's
prepared favorite and now I want as
little as possible call the seller you
want to get
much as possible so the idea is to
establish a range against a range to get
the negotiation going in and then
obviously sellers look to achieve the
top end of the range and buyers look to
achieve the bottom end of the range and
how does it work well three approaches
remember what I said about the house
just now
all right well I was a little bit loose
and fast with the facts
but those three approaches I described
also describe the way that you can go
about valuing an entire company okay one
of them is what's called the asset based
approach now in this video I'm just
going to introduce the language I'm not
going to go into this any detail but
essentially you could take a company's
balance sheet as a starting point you're
not sure on earth the balance sheet is
see my video it's a popular one what is
a balance sheet okay you could start
with a company's balance sheet look at
the list of assets make some adjustments
according to as a buyer whether you
think they're fairly safe store not and
come up with a kind of asset based
valuation but do you just stop there no
okay
because chances are you're not buying
the company to simply wind it up and
flog off the assets chances are you're
buying it
okay so predator for example RS and
invest you're looking at the longer term
so we're looking at what you can squeeze
out of it so another approach would be
the house next door approach okay this
is going to break some water approach
the house next door is called or well
I'll call it ratio based and if there's
demand we can cover the East other
videos okay we may come across this one
if you've done a bit of this stuff
before ratio base is essentially saying
well let's take similar companies so
ones from the sector that this company
operates in let's look at something like
their p/e ratio or their price to sales
ratio again topics I cover in other
videos what is a p/e ratio it was the
price to sales ratio okay and let's see
if we can come up with a sort of
comparative number for the company
we're looking at alright um now very
very simply very very simply this works
on this sort of premise you know the P
ratio is the relationship for example
putting the current share price of a
company and one year's earnings all
right so you know if you've got sort of
let's say a p/e ratio of ten okay you
can rearrange this formula if you like a
bit of maths and say well the value of a
firm is equal to just multiplying that
out ten times earnings all right if
you're into maths you can do a bit of
rearrangement okay so P is equal to 10
times earnings so what you can start to
then do is say well you know if I can
come up with the right earnings figure
and if I think that 10 is about the
right multiple to apply to the firm I'm
looking at based on other similar
companies I can start to come up with a
value for P that was a little bit quick
and dirty but you saw may get the basic
idea from there okay and the third and
biggest and Junkies method okay is
what's called discounted cash flow DCF
that's the kind of what's our property
worth looking at it's rental income in
the future time approached okay I'm not
going to cover that in this video could
do an entire video on that quite
comfortably that's the idea that what
you actually want to do is to forecast
the earnings and cash flows that the
company will generate looking into the
future and then bring them back to
today's money using what's called a
discount rate okay and I do cover that
in another video in outline terms okay
so there we have it want to introduce
their ideas all I've done here that
there are several ways you can value a
company and there's a predator obviously
is vital okay so you don't overpay for
it as an investor is quite important too
okay
so those three methods are asset based
bottom up take a balance sheet
see what the company is worth a balance
sheet point of view make some
adjustments based on what you think
assets and liabilities might really be
worth the ratio based approach that says
let's look at similar companies get a
handle on a typical multiple for the
sector and then take a number for the
company we're looking at and multiply to
get the price that can be done using the
p/e ratio the price to sales ratio it
depends on the company depend on sector
and the third approach which is a biggie
discounted cash flow okay that's used in
many many many situations okay it's
unusual to just do one of these quite
often you're funded two or three of them
DCF the hardest involves the most amount
of work projecting cash flows into the
future discounting them back to get a
price or a value today all right and
then armed with those different numbers
because these could easily throw out
three different numbers hopefully not
totally divergent you then begin if
you're buying a company the negotiation
on what you're actually going to pay
based on the range of these three
techniques are just generated hope
that's been useful see you in the next
video
you
