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Business Valuation
Dr. Chhavi Mehta
How You Differentiate?
VALUE
&
PRICE
Valuation
• Beauty Lies in the eyes of beholder
• Valuation has a story behind it, a good valuation is about story than
about numbers
• When valuation fail, they are not because of the numbers but
because of other factors
What are these Factors?
• Bias – preconceived notions
• Second:
– Minimise the stake in firm being over- and under-valued (institutional
investors concerns)
Institutional Investors’ Concerns
Equity research analysts are likely to issue ‘buy’ rather than ‘sell’
recommendation – they are more likely to find firms to be
undervalued than overvalued
Reasons
a. If information about the companies is difficult to get – sell
b. Pressure form portfolio managers and from their own investment banking
arm – some of them have large positions in the stock and have profitable
relationship with the firms in question
Imprecision and Uncertainty
in Valuation
Imprecision and Uncertainty in Valuation
• Valuation requires using forecasted numbers – They are only estimates
2. Firm-specific Uncertainty The path that we envision for a firm could prove to
be hopelessly wrong. The firm may do much better or much worse than we
expected it to perform, and the resulting earnings and cash flows will be very
different from our estimates.
• Remember:
– Valuation – Art and science both; more of art and than science
– Valuation models may be quantitative but the inputs are based on
qualitative assessment, so lot of scope for subjective judgement
– Final value we obtain from these models gets affected by various biases
Myth 2
A well-research and well done valuation is timeless
• Remember:
– Value of a firm = f(firm specific information, industry specific information,
market specific information) Value will change as new information is
revealed
– Give the constant flow of information into financial market, a valuation
done ages quickly and need to be updated continuously
Myth 3
A good valuation provides a precise estimate of value
• Remember:
– As valuation is based on the future estimated of the company (cash flows
and discount rates), there will always be uncertainty about the final
numbers
– Degree of precision is likely to vary across companies Valuation of large
and mature companies versus valuation of young companies; magnified
uncertainty due to emerging market
– Difficulties associated with valuation can be related to where the firm is in
the life cycle
– Problem arises not because of the model but because of the estimates, still
doing valuation is better than not doing it; keep a margin of errors
Myth 4
The more quantitative a model, the better the valuation
• Remember:
– As models become more complex, number of inputs needed to value a firm
tends to increase resulting in a possibility of more estimation errors
– As a valuation fails, the blame on the model instead of analyst
– Three things to remember:
• Adhere to the principle of parsimony
• Trade off between additional benefits of building a more complex model
and estimation cost
• You do the valuation not the models Problem of excess information,
so segregate between important and unimportant information
Myth 5
To make money on valuation, you have to assume that the markets
are inefficient and they will become efficient
• Remember:
– Some believe that markets are inefficient so they spend their time and
resources on valuation; some believe that markets are efficient should take
the market price as best estimate of value
– Approach the issue of market efficiency as a skeptic Recognize that on
one hand markets make mistakes but, on the other, finding these mistakes
requires a combination of skill and luck
– If something looks too good to be true, it is not probably so
– When a value from analysis is significantly from the market price, start off
with the presumption that market is correct
Myth 6
The product of valuation is what matters (the value), the process of
valuation is not important
• Remember:
– Risk in focusing exclusively on the outcome You might miss on some
valuable insights that can be obtained from the process of valuation
– Process can tell us great deal about the determinants of value and help us
answer some fundamental questions i.e.:
• What is the appropriate price to pay for high growth?
• What is the effect of profit margins on value?
Role of Valuation
• Valuation in Portfolio Management Valuation is the central focus
in fundamental analysis.