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Valuation

Valuation


The Headington Shark. 2017
I feel that to write an article about valuation  is a must in a finance blog and especially if the blog is focusing on long term investment opportunities. At the outset I would like to quote the classic Spanish writer Antonio Machado who said "Only a fool thinks price and value are the same".

The key of a good investment is to analyse the intrinsic value of a business, and try to buy it under this value.

There are many reasons to value a company: fix a fair price of company in an IPO (Initial Public Offer), what price to pay in a take over of a competitor company, a spin- off, companies which are involved in a liquidation process or only because you are a professional investor or non-professional investor and you want to incorporate new stocks in your portfolio.

There are different techniques of valuation but I be very arrogant if thought could explain I could explain all of them in a simple article. I  would just like to mention the two most commonly used methods:

  • Discount of free cash flows method: make a model with future earnings and discount then using a discount factor (cost of equity and cost of debt). This method is particularly useful in infrastructure projects and in a very stable business. The biggest constraint of this method is the amount of assumptions. This method is known as the most technical.  If you want to learn more I highly recommend the following website Damodaran. Damodaran is a teacher of corporate finance at New York University and  his website has  plenty  of data,  information by sectors, tools and articles. I love this website!!!
  • Valuation using multiples. e.g. A number of times the EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization). To do a correct calculation through this method we should use a normalised EBITDA which involves making some adjustments in order to remove non recurring expenses or revenues. For example if a company sells real estate and that is not part of his core business this revenue should be removed.
As a final consideration I would like to remind you  that you should not confuse enterprise value and equity value (enterprise value - debt).

I encourage you  to make your own valuation the next time you buy shares in the stock market but if you are lazy like me, be sure you choose an investment manager that can do this exercise for you. Good luck and do not confuse price with value anymore!!!

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