There are a number of different ways of valuing a company and a number of factors to take into account:
- Net Asset ValuationWhat are the assets? Tangible/intangible: Tangibles are generally the hard assets like plant & equipment, stock, debtors and cash. Intangibles are things like goodwill and IPR.Purchasers will generally ignore Intangibles on a Balance Sheet as it is effectively double valuing goodwill when pricing in a Goodwill Premium for the company.Very often a company will have its assets valued within its books at a price which can only be justified if the company is still in business, whereas if the company went into receivership those same assets may only be worth a fraction of their book value because of age, specialisation or difficulties in removing them from the premises.If the company is sold for Net Asset Value then there may also be redundancy and lease dilapidation and termination costs to be taken into account by a purchaser, which could depress the valuation.
- Accounting Rate of Return (ARR) or Return on Capital Employed (ROCE)This is essentially looking at the total amount of money required to buy and run the business (including all bank debt and HP leases), then looking at the EBIT (= earnings before interest and tax) and deciding whether that is a satisfactory return on the investment given the risks involved.
- Discounted cashflowsThis is an actuarial calculation involving calculating the overall cashflow demands and returns of the company over a period of say 7 years and then discounting them back to their net present value. It is safe to say that this method is usually only used for larger corporations or new and substantial businesses.
- Internal rate of Return (IRR)This method is generally used when the transaction is highly geared and is normally used by venture-capital investors. An example is, if you buy a £300,000 investment property with a £250,000 mortgage and then sell it three years later for £500,000 then your IRR (assuming that the mortgage has not reduced and the rent has equalled the mortgage interest costs) is going to be your capital gain of £200k as a percentage of your original investment of £50k divided by the number of years you held the investment. i.e. (250/50)/3 = 166%IRR
- P/E and MultiplesThis means looking at the pre and post tax profit of the company and then multiplying it by a number which is usually somewhere between 1-10. The lower the multiple means the higher the risk and the less sustainable the profit stream.The term “multiple” is usually used for pre-tax numbers and “p/e” for post-tax numbers. It is sensible however when using these terms to make it clear that you are talking about either pre or post tax numbers. There is a big difference between the two, a pre-tax multiple of 4 is about the same as a post p/e of 6.
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