INTRODUCTION TO

VALUATION
CONCEPTS
 Definition of Valuation

Types of Value

TOPICS Importance of Valuation

Standard Approaches

Limitations
 Valuation
WHAT IS VALUATION • is the process that links risk and return to
estimate the current (or projected) worth of
an asset or a firm.

• Is the determination of the monetary value

at some specific date, of the property rights
encompassed in an ownership.

• Property rights means the exclusive right to

possess, enjoy and dispose

• Requires application of logical principles

and tested methods leading to estimate of
value under given circumstances. In short,
valuation is both science and art as well.
 HOW?

In placing a value on a
company, an analyst looks at:
MS EM
(a) The business’s
What are the purpose of valuation?
management The purpose of a valuation is to track the effectiveness of
(b) The composition of its your strategic decision-making process and provide the
capital structure ability to track performance in terms of estimated change in
(c) Prospect of future earnings value, not just in revenue. This helps you to take a holistic
(d) Market value of the assets look at your business and make decisions that are highly
impactful for your bottom line. It allows you to understand
the subtle dynamics of your business and avoid unforeseen
consequences of seemingly insignificant decisions.
 TYPES OF VALUE
❑GOING CONCERN VALUE
• is the value of a firm as an operating business. This type of
value depends on the firm’s ability to generate future cash
flows rather than on its balance sheet assets. Going-
concern value is particularly important when one firm
wants to acquire another.

❑LIQUIDATION VALUE
• Liquidation value is the amount of money that a firm would
realize by selling its assets and paying off its liabilities. A
firm’s assets are generally worth more as a going concern
than they are worth separately. Liquidation value per share
is the actual amount per share of common stock that
stockholders would receive if the firm sells all assets, pays
all its liabilities including preferred stock, and divides any
remaining money among them.
TYPES OF VALUE
❑BOOK VALUE
• Book value is the accounting value of a firm or an asset. Book value is an
historical value rather than a current value. Firms usually report book value
on a per share basis.

❑MARKET VALUE
• Market value is the price that the owner can receive from selling an asset in the
market place. The key determinant of market value is supply and demand for the
asset. For stocks and bonds, market values reflect current market prices.

❑INTRINSIC VALUE
• Intrinsic value, also called fundamental value, is a measure of the theoretical
value of an asset. Because determining the intrinsic value requires estimates, we
may never know the “actual” or “true” intrinsic value of some financial assets.
Nonetheless, intrinsic value serves as a basis for determining whether to buy or
sell a financial asset when compared to its market value or price.
 IMPORTANCE OF VALUATION
CORPORATE
ANALYSTS INVESTORS
MANAGERS
✓ Determine if the market ✓ To help their clients (in a ✓ To know if they would
properly prices these assets merger, acquisition consider buying the
transaction, capital asset/entity or not.
✓ To estimate the price that their budgeting, investment ▪ If the estimate of intrinsic
firms are likely to receive when analysis, litigation and value exceeds an asset’s
issuing bonds or shares of financial reporting). market value (price),
common or preferred stock. investors would consider
✓ It is their work to know if buying the asset.
✓ To understand how corporate an asset or a company is ▪ If the market value (price)
decisions may affect the value undervalued or overvalued exceeds the estimated intrinsic
of their firm’s outstanding by the market. value, investors would not
securities, especially common consider buying the asset (or
stock. would consider selling if they
own it).
 STANDARD
APPROACHES

• Discounted Cash
Flow Valuation
• Relative Valuation
1. Discounted cash flow valuation
What? Basis:
DCF is a valuation method used to Every asset has an intrinsic value
estimate the value of an investment that can be estimated, based upon its
based on its expected future cash characteristics in terms of cash
flows. It attempts to figure the flows, growth and risk.
present value of the investment
based on how much money it will
generate in the future.

Assumption:
‐ Market make mistakes in valuing individual companies and that they are
correct these mistakes over time.
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3 ingredients to get the present value (LCD)

1. Life of the asset, (when your business will mature, I cannot

estimate cash flows forever, much preferred- long time
horizon)
You need long time horizon because market can make mistakes, they can find those
mistakes but there is no guarantee that those mistakes will get corrected in the next
months, or year. The longer time horizon the better off you are using this kind of cash flow
valuation

2. the cash flows during the life of the asset

3. the discount rate
Last January 1, 2021, Company X bought a company What is the DCF of a company
with an expected cash flow for 100,000 for 2022 and is
that has a cash flows for year 1
expected to grow by 3% per year for 5 years. How much
is the DCF of such company if it is to be compounded by
to year 5 of 100,000 per year,
15%. cost of capital of 10%
Discounted
YEAR Cash Flows PV of 1
CF
Cash Flows PV of OA Discounted CF

1 100,000 0.86957 86,957 100,000 3.79079 379,079

2
103,000 0.75614 77,882

3
106,090 0.65752 69,756

4 109,273 0.57175 62,477

5 112,551 0.49718 55,958

Total 353,030
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 Advantages Disadvantages
◉ It should be less exposed to market
moods and perceptions. (if you don’t trust
◉ It is difficult to estimate
crowd to make the judgement, intrinsic
valuation is for you) ◉ It can be manipulated by the analyst to
provide the conclusion that he or she
◉ Discounted cash flow valuation is the wants
right way to think about what you are
getting when you buy an asset.

◉ DCF valuation forces you to think about

the underlying characteristics of the firm,
and understand its business.

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 Relative Valuation
What? Basis:
The value of any asset can be The intrinsic value of an asset is
estimated by looking at how the impossible (or close to impossible) to
market prices “similar” or estimate. The price of an asset is
‘comparable” assets whatever the market is willing to pay
for it (based upon its characteristics)

Assumption:
The markets are right on average but that they’re wrong in individual companies
and that they’re wrong in individual companies that those mistakes will get
corrected sooner rather than later.

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3 ingredients to get the relative value (Imc)
1. Identify comparable assets and obtain market value for these assets

2. Create price multiples: Convert market values into standardized values, since
the absolute prices cannot be compared.
3. Compare multiples of the asset being analyzed to the multiples for
comparable assets and control any differences between the firms to judge if the
asset is under value or over value.
 Advantages Disadvantages
◉ In sync with the market: Relative valuation is ◉ Relative valuation is built on the assumption
much more likely to reflect market that markets are correct in the aggregate, but
perceptions and moods than discounted cash make mistakes on individual securities. To
flow valuation. This can be an advantage the degree that markets can be over or under
when it is important that the price reflect valued in the aggregate, relative valuation will
these perceptions as is the case when fail.

*the objective is to sell an asset at that price today ◉ Relative valuation may require less
information in the way in which most analysts
(IPO, M&A)
and portfolio managers use it. However, this
is because implicit assumptions are made
* investing on “momentum” based strategies
about other variables (that would have been
required in a discounted cash flow valuation).
◉ Relative valuation generally requires less To the extent that these implicit assumptions
explicit information than discounted cash are wrong the relative valuation will also be
flow valuation wrong.

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When to use:
◉ This approach is easiest to use when

¤ there are a large number of assets comparable to the one being valued

¤ these assets are priced in a market

¤ there exists some common variable that can be used to standardize the price

◉ This approach tends to work best for investors

¤ who have relatively short time horizons

¤ are judged based upon a relative benchmark (the market, other portfolio managers
following the same investment style etc.) 16
LIMITATIONS IN VALUATION

Imprecision
Bias & Complexity
Uncertainty

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1. BIAS

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You are valuing your own business for sale to a third
person.

❑ High
❑ Low

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You are a sell side equity research analyst, valuing a
company with the intent of putting a buy or sell
recommendation on it.

❑ High
❑ Low

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You are buy-side analyst, valuing a company for
your portfolio manager, who already happens to
own a million shares of its stock.

❑ High
❑ Low

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You are an analyst, working for the banker for the
acquirer in a friendly takeover, valuing the target
company.

❑ High
❑ Low

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You are an analyst, working for the banker for the
target in a friendly takeover, valuing the target
company.

❑ High
❑ Low

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You are valuing your own business for divorce
court; half of your estimated value will go to your
spouse (soon to be ex-spouse)
❑ High
❑ Low

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You are an appraiser for the owner, valuing a
business for tax purposes.

❑ High
❑ Low

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You are an appraiser for the BIR, valuing the
business for tax purposes
❑ High
❑ Low

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 Bias: effect
* Preconceptions and priors: When you start on the valuation of a
company, you almost never start with a blank slate. Instead,
your valuation is shaped by your prior views of the company in
question.

1 ¤ Corollary 1: The more you know about a company, the more likely
it is that you will be biased, when valuing the company.
¤ Corollary 2: The “closer” you get to the management/owners of a
company, the more biased your valuation of the company will
become.

*Value first, valuation to follow: In principle, you should do your

valuation first before you decide how much to pay for an asset.
In practice, people often decide what to pay and do the
valuation afterwards.
 Bias: the source
The power of the subconscious: We as human, after all, and as a
consequence are susceptible to bias.

The power of suggestion: Hearing what others think a company is worth

will color your thinking, and if you view those others as more

2 informed/smarter than you are, you will be influenced even more.

The power of money: If you have an economic stake in the outcome of a

valuation, bias will almost always follow.

¤ Corollary 1: Your bias in a valuation will be directly proportional to who

pays you to do the valuation and how much you get paid.

¤ Corollary 2: You will be more biased when valuing a company where

you already have a position (long or short) in the company
 Bias: what to do.
Ways in which we can mitigate the effects of bias on valuation:

1. Reduce institutional pressures

2. De-link valuations from reward/punishment

3 3. No pre-commitments: Decision makers should avoid taking

4.
strong public positions on the value of a firm before the
valuation is complete.

Self-Awareness

Be honest with yourself about your biases, and from personal

experience, that’s not easy to do

5. Honest reporting: The analyst should reveal their priors

(Biases) before they present their results from an analysis.
2. Imprecision
& Uncertainty

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 Reasons for uncertainty
a. Estimation Uncertainty: Even if our information sources are
impeccable, we have to convert raw information into inputs and use
these inputs in models. Any mistakes or mis-assessments that we
make at either stage of this process will cause estimation error.

1 b. Firm-specific Uncertainty: The path that we envision for a firm can

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.

c. Macroeconomic Uncertainty: Even if a firm evolves exactly the way we

expected it to, the macro economic environment can change in
unpredictable ways. Interest rates can go up or down and the
economy can do much better or worse than expected. These macro
economic changes will affect value.
 Responses to uncertainty
Valuation Ranges: A few analysts recognize that the value that they obtain for a
business is an estimate and try to quantify a range on the estimate.

Probabilistic Statements: Some analysts couch their valuations in probabilistic

2 terms to reflect the uncertainty that they feel. Thus, an analyst who estimates a value
of $ 30 for a stock which is trading at $ 25 will state that there is a 60 or 70%
probability that the stock is under valued rather than make the categorical statement
that it is under valued.

Building better models and accessing superior information

3. Complexity

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 Cost of complexity
Information Overload: More information does not always lead to better
valuations. In fact, analysts can become overwhelmed when faced with vast
amounts of conflicting information and this can lead to poor input choices. The
problem happened by the fact that analysts often operate under time pressure

1 when valuing companies.

Black Box Syndrome: The models become so complicated that the analysts using
them no longer understand their inner workings. They feed inputs into the
model’s black box and the box spits out a value.
Thanks!
Any questions?

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