Methods of Valuation- Is Valuation a scam?

Valuation is a science and an art. Valuation is a sort of realty check of business. However, Valuation can sometimes be too optimistic as well which can be observed from recent IPO listings, which kept tanking at the Stock market.

A business valuation done appropriately would save business from going on verge of breakdown. The value of business can be enhanced by understanding the Focus area or core area, which earns the most of the revenue. Valuation is a maze like Jantar Mantar, it depends where you reach, when you reach on the path you have CHOSEN. It

The irony of valuations is that the old businesses are either not able to get the flavours of valuation rightly or not getting properly judged. The new businesses are however given the best of valuations, the problem is it makes the valuations superficial to some extent. Like in case of Zomato, Paytm etc the valuation is huge, but ultimately it is showing losses in Business. Hence the losses are not liable for taxation and so enjoying the tax holiday.

The losses in business are nothing but an indirect instrument of tax escaping or planning it systematically. It is very ironical THAT 6 TECH ENABLED COMPANIES lost more than INR 1.2 lacs crores in January 2022, all the big names involved in erosion of capital like Paytm, Zomato, Nykaa, Policy Bazaar, Car trade and Star Health. All these start ups are in different segment, which involved lot of capital initially be offering various discount coupons, coupon codes, cash back and various composite saving schemes.

Now when there IPO is listed the investors can either stay or exit if listing gains are available. In

A business valuation needs lot of business acumen and patience to predict how future will unfold. The potential can be tremendous, like in 2012 when Facebook acquired Instagram for 1billion USD, a company having only 13 employees back then, it was considered to be crazy and egregious. Now after almost 10 years of acquiring the Instagram generates 20 billion USD revenue for FB; having 1 billion users.

Not every valuation will be successful, some would be failed as well like Jabong,Hike. The erosion of capital can’t be avoided in such scenarios. Either the big ones will acquire the small one if any potential is there and take advantage of the losses mounted up by them, use the distribution channels set up them, goodwill created by them or any other resources created by them.

Growth investing, by its very definition, is hard and for good measure. Profits in many businesses tend to revert to mean, and this hits the investor hard especially when one overpays to own such businesses, at the wrong end of the cycle.

Need of Valuation-

• Sale/ Purchase of business
• Merge or Acquire another company
• Business financing or investors
• Partner ownership percentages
• Entry of investors/ shareholders or exit
• Divorce proceedings
• Tax purposes

Growth feels good at times when it gels with a narrative. A narrative can be a magic wand for valuation. Start-ups have generally got a story of its own. That is the biggest alpha factor for its growth.

A positive alpha is the extra return awarded to the investor for assuming a risk, instead of accepting the market return. Alpha may be seen as a measure of a fund manager’s performance. Alpha is the excess return on an investment after adjusting for market-related volatility and random fluctuations

Methods of Valuation-

There are numerous ways of valuing a business. Multiple methods can be applied to conclude the appropriate value.

1. Market Cap Method-

Market Capitalisation is the simplest method of business valuation. It is calculated by multiplying the company’s share price by its total number of shares outstanding. For example, Market Cap of Facebook, it is simply the outstanding number of shares (2.872 billion) x Price ($123.18) = $353.73 billion. Enterprise Value is a better measure, we agree, but you need to calculate market cap for getting enterprise value.

Enterprise value is the total price of buying a company as it calculates the accurate value of a company.

The formula to calculate EV would be;

Enterprise Value = market value of common stock or market cap + market value of preferred shares + total debt (including long and short-term debt) + minority interest – total cash and cash equivalents.

2. Times Revenue Method

Under the times revenue business valuation method, a stream of revenues generated over a certain period of time is applied to a multiplier which depends on the industry and economic environment. For example, a tech company may be valued at 3x revenue, while a service firm may be valued at 0.5x revenue.

3. Earnings Multiplier

The earnings multiplier may be used to get a more accurate picture of the real value of a company, since a company’s profits are a more reliable indicator of its financial success than sales revenue is. The earnings multiplier adjusts future profits against cash flow that could be invested at the current interest rate over the same period of time. In other words, it adjusts the current P/E ratio to account for current interest rates.

4. Discounted Cash Flow (DCF) Method

The DCF method of business valuation is similar to the earnings multiplier. This method is based on projections of future cash flows, which are adjusted to get the current market value of the company. The main difference between the discounted cash flow method and the profit multiplier method is that it takes inflation into consideration to calculate the present value.

5. Book Value or Asset Based Method

This is the value of shareholders’ equity of a business as shown on the balance sheet statement. The book value is derived by subtracting the total liabilities of a company from its total assets. It can be further sub divided into 2 parts.

A. Going Concern

Businesses that plan to continue operating (i.e., not be liquidated) and not immediately sell any of their assets should use the going-concern approach to asset-based business valuation. This formula takes into account the business’s current total equity—in other words, your assets minus liabilities.

B. Liquidation Value

On the other hand, the liquidation value asset-based approach to valuation is based on the assumption that the business is finished and its assets will be liquidated. In this case, the value is based on the net cash that would exist if the business was terminated and the assets were sold. With this approach, the value of a business’s assets will likely be lower than usual—as liquidation value often amounts to much less than fair market value.

The liquidation value is always an urgent approach to value a business. Not a fair value is ascertained for this.

People want to buy only the cheap business, so they can take advantage once they get high valuations. This is how a human mind is wired– we want to buy cheap – the only issue with this is, in many cases, the businesses that are cheap have a fundamental flaw around their structure and culture which keeps them cheap. There fundamentals are always questionable and unreliable.