What Is the Valuation Approach?

Company valuation, also known as corporate valuation, corporate valuation, etc. Corporate valuation refers to the evaluation of the intrinsic value of a listed or unlisted company. Generally speaking, a company's assets and profitability are determined by its intrinsic value.

Company valuation

(Financial concept)

Company valuation, also known as corporate valuation, corporate valuation, etc. Corporate valuation refers to focusing on listed or unlisted companies

Financial models and corporate valuation models are important tools for seller and buyer analysts and are widely used in various transactions such as ^[1]

Based on whether the company continues to operate, the basis of the company's valuation can be divided into: ^[2]

The logic of company valuation lies in "value determines price". The valuation methods of listed companies are generally divided into two categories: one is the relative valuation method; the other is the absolute valuation method. The valuation methods of non-listed companies can be divided into three categories: market method; income method; asset method ^[2]

In practice, the selection of a company's valuation model should mainly follow two principles. First, the selected valuation model should be compatible with the basic characteristics of the company being evaluated so that the valuation model can better estimate the company's intrinsic value. Second, the choice of valuation model should meet the purpose of valuation, and the choice of model is different for different purposes.

Valuations obtained using different valuation models may vary. When multiple valuation models are used, it is best to express the company's valuation results using interval estimates rather than point estimates. If in practice it is necessary to obtain a clearer valuation, the Bayesian method or partial least squares method can be used to integrate the valuations of different companies into one valuation, and then the adjusted integration can be adjusted manually according to the actual situation. Valuation makes it more reasonable. Among them, the partial least squares method is most suitable for listed company related transactions, using market price as the explanatory variable and valuation as the explanatory variable, and using regression coefficients to integrate multiple estimates.

When investing in stocks, ordinary investors usually use the relative valuation method to value listed companies. The relative valuation method usually uses the price-earnings ratio (market price to earnings per share) or price-to-book ratio (market price to net assets per share) And other indicators, and the calculation of price-earnings ratio or price-to-book ratio indicators, the main financial indicators are based on earnings per share and net assets per share. Due to changes in accounting methods, the new standard can significantly change the earnings per share and net assets per share of listed companies. Investors making buying or selling decisions based on these indicators may cause unnecessary losses. Therefore, investors must focus on any significant changes in accounting methods under the new standard. In addition, investors need to keep in mind:

1. Market leaders usually have higher valuations.

2. Most markets only have the boss, the second and the third, and the others are not important.

3. There must be a growth plan to allow the company's business to go beyond its current state, thereby maintaining valuations.

4. It is stupid to estimate the value of a company based on the cost of creation (copying). The real value lies in customers, revenue, growth prospects, not how much money the company spent when it was founded.

5. Never underestimate the response of competitors in the face of rapid growth.

6. When market leaders are in a period of rapid growth (investment), inertia is important ^[3]

Initial Public Offering refers to the initial approval

Ba Lao's opinion is to turn complexity into simplicity:

1. The so-called company value is the discounted value of the cash flow that a company can generate in the rest of its life; the intrinsic value is only an estimated value, not an exact value, but also an estimated value that must be changed when the interest rate or cash flow changes. . Barlow also emphasized that "internal value provides the only logical means for assessing the relative attractiveness of investments and businesses." Therefore, it is difficult to try to make an accurate valuation. Our analysts often estimate EPS to a few cents, and the valuation of specific stocks is often accurate to cents. Obviously this is a "precise error."

2. In terms of specific valuation methods, Palo agrees with the discounted cash flow method in John Burr Williams's Investment Value Theory. In his 2000 annual report, Pharaoh quoted Aesop's Fables that "a bird in hand is better than two birds in the forest", which meant that "certainty is the most important". Balao does not agree with the relative valuation method. He said that "general valuation standards, such as dividend yield, PE, PB or growth, have nothing to do with value assessment, unless they can provide a company's future cash inflows and outflows to a certain extent. In fact, if the initial investment of a project exceeds the discounted value of the cash flow generated by its assets after the project is completed, growth will destroy the value of the enterprise. Some analysts have vocally classified the 'growth' and 'value' columns. For two diametrically opposite investment styles, they can only show their ignorance. It is by no means true knowledge. Growth is only one of the factors in value evaluation, generally positive factors, but sometimes negative factors. "Therefore, Barao insists on absolute valuation. He never agreed with relative valuations, saying that they were "irrelevant to valuation."

3. How to choose cash flow and discount rate? Since the absolute valuation method is the only valuation method, how to determine the cash flow and discount rate?

As for cash flow, Palo insists on "owner income" (actually free cash flow). It can be said that this is the dead end of many relative valuation methods. The financial statements artificially follow the assumption of "accounting instalments", and artificially cut the operating cycles of some companies into one year and one year, but in fact, the fiscal year often does not match the company's operating cycle, and many companies' earnings often fluctuate . For example, the average annual profit of a non-cyclical company and a cyclical company in the next 10 years will be 100 million, but the valuation of a non-cyclical company may be 2.5 billion, while the valuation of a cyclical company may only be 1 billion or even 6 Billion, what's the reason for this? From the point of view of profit alone, there is no problem. The reason lies in free cash flow. For cyclical companies, for the same level of income, they often need to increase working capital and long-term operating assets. Cyclic companies are much lower. Therefore, roughly estimated capital expenditures and additional working capital are also more important than seemingly accurate discounting of cash flows.

As for the discount rate, Pakistan uses the long-term government bond rate. This is well understood. Ba Lao values opportunity cost. If a stock's future yield does not outperform long-term government bonds, he will not choose it at all; CAPM has natural flaws, and he believes that is logically unreasonable. Moreover, the future level of risk is not constant, and the risk-free interest rate is not constant. Barao chose a company with a sustainable competitive advantage. For him, there is no other uncertainty in the future. He simply uses the long-term government bond rate as the discount rate.

Regarding the absolute valuation of Pharaoh, there are many examples in the book "The Road to Buffett", such as Coca-Cola and Geely.

4. How to crack mines in absolute valuation? Facing the uncertainty of the valuation, Pharaoh proposed two solutions: a. Adhere to the principle of the ability circle and stick to the industry that he can understand; b. Persist in maintaining a large margin of safety in buying. Palo said that "the market price of an asset is only slightly lower than its intrinsic value, and we are not interested in buying it; we only buy it when there is a" significant discount "".

5. The most fundamental method of valuation: a thorough understanding of this company.

In short, company valuation is an art, and realizing its true meaning requires hard work. Value investors must value valuation. Without valuation, the margin of safety cannot be determined. To abandon the aristocratic complicated valuation method, it is also necessary to abandon the absurd "EPS forecast + PE valuation" method and reduce complexity to simplicity. As long as you are on the right path, persevere, work harder, and master the background knowledge of some industries, the problem of valuation can be solved ^[3] .