Valuation - An Overview - Session 1
- 1. VALUATION - OVERVIEW CA PITAM GOEL CA TUSHAR AGGARWAL 24th March 2020 – Session 1 Enhancing Enterprise Value 1VPTP & Co - Copyright
- 2. QUOTE 2VPTP & Co - Copyright Aswath Damodaran – Valuation GURU He said that equity analysts are like ones who knows the price of everything but not the value. He said – “… a surprising number of whom subscribe to the 'bigger fool' theory of investing, which argues that the value of an asset is irrelevant as long as there is a 'bigger fool' willing to buy the asset from them.”
- 3. WHAT IS VALUATION ????? • In a science, if you get the inputs right, you should get the output right • The laws of physics and mathematics are universal and there are no exceptions. • Valuation is NOT SCIENCE SCIENCE • In an art, there are elements that can be taught but there is also a magic that you either have or you do not. • The essence of an art is that you are either born a great artist or you are not. • Valuation is NOT ART ART • A craft is a skill that you learn by doing. • The more you do it, the better you get at it. • Valuation is a CRAFT CRAFT 3VPTP & Co - Copyright
- 4. VALUE VS PRICE 4VPTP & Co - Copyright • Value is a measure of how much an asset is 'worth' • Valuation standard defines Value as economic concept, an estimate of likely price at a given time. • Valuation is a process or method for computing Value VALUE • Price is "Amount of money / other means of consideration asked for or given in exchange for the asset" • Price may or may not have a relationship with the value of the underlying asset • Price is an outcome of an transaction PRICE Value Price Not precisely measurable Can be measured precisely Not a static figure Static figure defined by transaction Measure of economic value Takes into consideration non- economic factors Question for thought: Does price of an asset define its value?
- 5. VALUE VS PRICE 5VPTP & Co - Copyright Particulars To Value To Price Assets Can be valued based upon expected cash flows , with higher cash flows and lower risk = higher value Can be priced against similar assets, after controlling for cash flows and risk. Commodity Can be valued based upon utilitarian demand and supply, but with long lags in both. Can be priced against its own history (normalized price over time) Currency Cannot be value Can be priced against other currencies, with greater acceptance & more stable purchasing power = higher price. Collectible Cannot be value Can be priced based upon scarcity and desirability.
- 6. VALUE VS PRICE 6VPTP & Co - Copyright Drivers of Intrinsic Value 1 Cash flows from existing assets 2 growth in cash flows 3 Quality of growth Accounting Estimates Valuation Estimates INTRINSIC VALUE THE GAP Is there one ? If so, will it close ? If it will close, what will cause it to close? PRICE Drivers of price 1 Market moods and momentum 2 Surface stories about fundamentals Value
- 7. METHOD OF VALUATION 7VPTP & Co - Copyright INTRINSIC VALUE RELATIVE VALUATION CONTINGENT VALUATION
- 8. METHOD OF VALUATION 8VPTP & Co - Copyright Ways of thinking about estimating value Intrinsic Value The value of an asset is the present value of the expected cash flows. Relative value/ Pricing The value of an asset is what others are willing to pay for it (or something like it) Contingent Value The value of an asset may be contingent on what happens to other assets. Value Enhacement • Management • Activist investors Acquisitions • Synergy • Control ChangingValue Every asset has a value. We just have to find it Investors 1 Small VS large 2 Short term vs long term 3 Individual vs institutional 4 Insider vs outsiders Analysis - Buy side vs sell side Accountants Regulators/ GovernmentWays of Applying value Valuing publicly traded firms 1 small vs large 2 Developed vs emerging 3 Manufacturing vs technology And private businesses 1 For owners 2 and investors (Private equity, venture capital, IPO) Cross the life cycle 1 Young firms 2 IPOs 3 Mature firms 4 Declining firms In sickness and in health 1 Survival risk 2 Distress risk 3 Nationalization risk.
- 9. VALUATION THEORY – STORY + NUMBER 9VPTP & Co - Copyright Appeal Numbers provide a sense of control, a sense of precision and the appearance of objectivity . The Number crunches Dangers Without narratives to back them up, numbers can be easily manipulated, used to hide bias or to intimidate those not in the loop. A Good Valuation Story + Numbers Appeal Stories are more easily remembered than numbers and connect with human emotions. Dangers Stories that are not anchored to or connected with numbers can veer into fairy tales, leading to unreal valuations. The story tellers
- 10. BERMUDA TRIANGLE - VALUATION 10VPTP & Co - Copyright Valuation First Principles & Good sense Uncertainty and the Unknown Paralysis Outsourcing Herding Mental accounting
- 11. BIASONESS IN VALUATION 11VPTP & Co - Copyright Intrinsic Value : The Biasers Treat operating expenses as one- time or extraordinary & Ignore Cash flow from existing Investments. Treat one – time income as continuing income Replace risk free rate with lower normalized rate. Assume a lower relative risk even or beta Use lower or no equity risk premium Use a higher target debt ratio, without adjusting other inputs. Discount Rate of Cash Flows Value of Growth While reducing reinvestment (capital expenditures and working capital) Push up growth rate in revenue and increase operating margins. Terminal value of firm (equity) Gordon Growth Model Use a stable growth rate> growth rate of economy. Grow with no reinvestment Assume very high excess returns in perpetuity
- 12. MISCONCEPTIONS ABOUT VALUATION 12VPTP & Co - Copyright Myth1 : A valuation is an objective search for “true” value Truth 1.1: All valuations are biased. The only questions are “how much and which direction”. Truth 1.2: The direction and magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid Myth2 : A good valuation provides a precise estimate of value Truth 2.1: There are no precise valuations. Truth 2.2: The payoff of to valuation is greatest when valuation is least precise. Myth3 : The more quantitative a model, the better the valuation Truth 3.1: Your understanding of a valuation model is inversely proportional to the number of inputs required for the model. Truth 3.2: Simpler valuation models do much better than complex ones.
- 13. THANK YOU Delhi Office: JD-2C, 2nd Floor, Pitampura, Near Pillar No. 355, Rithala, Dilshad Garden, New Delhi, Delhi 110034 Gurgaon Office: Plot No. 508, Sector-40, Gurugram, Haryana, 122003. Email: pitam@vptp.in Website: www.vptp.in Contact: 9953107107, 9650777079 Associate Firm