Business Valuation Methods
Do the number of valuation models make your head spin? It’s easy to get confused when you’re looking to sell your business about exactly what’s the proper valuation model to use, and how they’re all different.
In this post, we were fortunate to tap into the expert on one of the most respected authorities on valuation in the world, Dr. Aswath Damodaran.
Dr. Damodaran is a Professor of Finance at the Stern School of Business at New York University, where he teaches corporate finance and equity valuation. As his biography on the Stern School’s website indicates:
Professor Damodaran’s contributions to the field of Finance have been recognized many times over. He has been the recipient of Giblin, Glucksman, and Heyman Fellowships, a David Margolis Teaching Excellence Fellowship, and the Richard L. Rosenthal Award for Innovation in Investment Management and Corporate Finance.
In addition to myriad publications in academic journals, Professor Damodaran is the author of several highly-regarded and widely-used academic texts on Valuation, Corporate Finance, and Investment Management.
While Prof. Damodaran does a great deal of his work assessing the value of publicly-traded companies, was kind enough to share some insights on valuation that can be applied to small and mid-sized companies in the printing and print-related industries.
In this post, we will define:
- Some myths about valuation, and what you can really expect from a valuation
- The three approaches to business valuation – and how they influence difference methods
- Valuation vs. Pricing – How this applies to setting a price for your printing business
Business Valuation Myths: Can You Really Produce an Accurate Valuation?
In his teachings on valuation, Professor Damadoran starts by highlighting some of the myths of valuations.
Myth 1: A valuation is an objective search for “true” value
Dr. Damadoran notes that “all valuations are biased. The only questions is ‘how much’ and in which direction. Further, he also notes that the “direction of the magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid.”
That’s entirely why we encourage independent, third-party appraisals for each business valuation. Yet his point is well taken; bias can impact a valuation, and the idea that a “true value” can be measured is unrealistic.
Myth 2: A good valuation provides a precise estimate of value
Dr. Damadoran believes there are no precise valuations, and that the “payoff to valuation is greatest when valuation is least precise.”
Myth 3: The more quantitative a model, the better the valuation
Your understanding of a valuation model is inversely proportional to the number of inputs required for the model. He notes that “Simpler valuation models do much better than complex ones.”
Many Different Business Valuation Methods, But Only Three Approaches
Valuation experts will also site multiple methods for establishing a business’s value. With a nod to Prof. Damadoran’s views on simpler valuation models, it’s more important to understand the three overall approaches to valuation.
Once you’ve grasped these concepts, you can understand that particular method that’s being used
Intrinsic Valuation
With this method, you’re really looking what truly makes up the value of your company, and project how the future will impact that value.
Essentially, intrinsic value “relates the value of an assets to its intrinsic characteristics: Its capacity to generate cash flows and the risk in its cash flow.” Also referred to as “Discounted cash flow valuation,” it “forces you to think about the underlying characteristics of the firm, and understand its business.”
Relative Valuation
The “market perceptions and moods” are reflected in this approach, as an approach to the intrinsic valuation. This is used when your objective is to “sell an asset at that price today” and invest in the “momentum” based strategies.
With the current state of the market taken into account, Prof. Damodran notes that “there will always be a significant proportion of securities that are under-valued and over-valued.” Note: In this case, we’re substituting your “company” for “securities.”
Contingent Claim Valuation
In the third approach, you analyze assets. This method may be used where you’re liquidating a business; valuing a business’s assets for accounting reasons; or using a “sum of the parts” valuation,” in which someone is using targeting an acquisition as a “cheap investment.” We see it in truck-in transactions.
Business Valuation: Is it in the Eye of the Beholder?
The three approaches can produce different results. “The three approaches can yield different estimates of value for the same asset at the same point in time.”
That’s why one valuation may produce a number of different values: It all depends on the intent of the valuation and how it’s being used to justify the price. It’s also calculated in relation to the market place. Again, Prof. Damadoran:
“The Use of valuation models in investment decisions (i.e. decisions on which assets are undervalued and which are over-valued are based upon:
- A perception that markets are inefficient and make mistakes in assessing value
- An assumption about how and when these inefficiencies will be corrected
In an efficient market, the market prices is the best estimate of value. The purpose of any valuation model is then the justification of this value.”
So don’t think of the valuation model as setting the price. The market sets the price. The valuation helps to justify it. We noted this when we discussed it in the previous article – the multiple you can charge is not as much based upon the marketplace as it is upon your own internal performance.
Which Approaches Are Used for Printing Industry?
This is largely dependent on the objectives of your sales. “There is a time and a place for each approach,” Professor Damodoran notes, “and knowing when to use each one is a key part of mastering valuation.
What we see typically is the use of the intrinsic value for most companies in the printing and print-related industries. In order to demand a higher multiple, you need bigger margins.
As Darren Mize noted, “Like most companies, printing companies become more valuable with higher margins and smaller asset turnover (meaning doing more with less) – the larger companies don’t necessarily equate to a higher value. Back in the early 2000s printing companies were hot and selling for large multiples but today they have come back to the pack.”
In growing sectors, the Relative Valuation might be more applicable. Smart labeling technologies (the subject of an upcoming post) might influence a business valuation, for example.
Prof. Damodaran echoes Darren Mize’s statement. “I have no idea what that multiple would be a printing business, my guess would be that if margins are your key differentiator across companies, it would be a revenue multiple.”
Indeed, EBIDTA, at the end of the day, still seems to be the primary factor in what moves the dial for investors. So how do you price for the future?
It really depends on your vision, your marketing strategy, but most importantly, how many clients you have locked into long-term agreements, or “multi-year contracts” as Vince Mallardi notes, “Find the tangible bottom line. After that, the only thing you have is your contracts.”
Even if the buyer will have to discount the cash flow into net present value, those multi-year contracts can be extremely valuable to a buyer.
Real value is determined by industry-specific multiples.