What method do you think is most reliable for determining the value of a business?
Baker Tilly has recently posted the question of which of the following valuation methods can be considered the most reliable valuation of a company:
1) discounted cash flow,
2) comparable companies’ method,
3) precedent transactions, or
4) asset-based valuation.
The results came mixed as below
Baker Tilly believes that there is no single reliable valuation methodology. Determining the most reliable valuation method depends on the context and specific circumstances of the company being valued. Each method has its strengths and weaknesses, and their reliability can vary depending on factors such as the company's industry, stage of development, and the purpose of the valuation. Ideally, a combination of methods provides the most comprehensive and reliable valuation by balancing different perspectives and insights.
?Below is a comparative brief overview of each method to help identify which might be considered the most reliable in different scenarios:
?DISCOUNTED CASH FLOW (DCF)
?The DCF valuation method provides an intrinsic value focus and values a company based on its projected future cash flows, discounted to present value to capture the company’s potential to generate future cash. It looks at the detailed financial projections and can be tailored to specific business circumstances and risks. However, even with the above strengths, the DCF is assumption Dependent as it is highly sensitive to the accuracy of future cash flow projections and the discount rate. Small changes in assumptions can significantly impact valuation. Furthermore, it is complex as it requires detailed forecasts and assumptions, which can introduce errors if not carefully considered. The DCF valuation is best for companies with stable and predictable cash flows, such as mature businesses with a clear path to future profitability.
?COMPARABLE COMPANIES METHOD (CCM)
?The CCM strengths stem from being a market-based method for it reflects how similar companies are valued in the market, providing a real-world perspective on valuation. It is a relatively simple method based on readily available market data that makes it straightforward to apply and understand. However, that simplicity is faced with potential weaknesses mainly related to comparability issues, which strongly depends on finding truly comparable companies for differences in size, growth rates, or market conditions can affect the reliability of comparisons. Furthermore, the valuation results by the current market conditions may be influenced by short-term trends or market volatility. The CCM is best when there are adequate comparable companies and when market conditions are stable and is commonly used for industry benchmarking.
?PRECEDENT TRANSACTIONS METHOD (PTM)
?The PTM is based on actual transaction prices, providing a realistic measure of what buyers have recently paid for similar companies, and is particularly relevant in merger and acquisition contexts where recent transaction data can provide insight into valuation norms. However, it relies on the availability of relevant transaction data and finding truly comparable transactions can be challenging. Furthermore, other transactions prices may include premiums for strategic value or synergies, which might not apply to the company being valued. The PTM is best used for assessing value in the context of mergers and acquisitions, or when evaluating market-based transaction trends.
?ASSET BASED VALUATION (ABV)
?The ABV is less reliant on subjective forecasts and instead provides a clear picture of the value of tangible assets and liabilities and is mostly useful for asset-heavy businesses. However, the ABV may inadvertently undervalue companies with significant intangible assets or growth potential, and it does not account for future earnings potential or business growth. The ABV is best for companies with significant tangible assets or in situations where liquidation value is a concern.