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Methodologies of valuation


Corporatevaluations.in-Uncoding the Code-Methodologies of Valuation

Asset Based Method (NAV)

The asset based method views the business as a set of assets and liabilities that are used as building blocks to construct the picture of business value. Since every operating business has assets and liabilities, a natural way to address this question is to determine the value of these assets and liabilities. The difference is the business value. However, the Net Asset Value reflected in books do not usually include intangible assets and earning potential of the business and are also impacted by accounting policies which may be discretionary at times. Thus, NAV is not perceived as a true indicator of the fair business value. However, it is used to evaluate the entry barrier that exists in a business and is considered viable for companies having reached the mature or declining growth cycle and also for property and investment companies having strong asset base.

Adjusted Net Asset method - For Calculating the Adjusted NAV, the valuer should factor in the contingent liability, Tax Shield on accumulated losses, impact of Auditor qualification and Due Diligence, money to be received from warrants, stock options and impact of corresponding shares.

Income Based Method

The Income based method of valuations are based on the premise that the current value of any business is a function of the future value that an investor can expect to receive from purchasing all or part of the business. It is generally used for valuing businesses that are expected to continue operating for the foreseeable future.

Capitalization of Earning Method (PECV):

In its simplest form, the capitalization method basically divides the business expected earnings by the so-called capitalization rate. The idea is that the business value is defined by the business earnings and the capitalization rate is used to relate the two.

The first step under this method is the determination the capitalization rate - a rate of return required to take on the risk of operating the business (the riskier the business, the higher the required return). Earnings are then divided by that capitalization rate. The earnings figure to be capitalized should be one that reflects the true nature of the business, such as the last three years average, current year or projected year excluding the impact of any extraordinary items not expected to accrue in future. While determining a capitalization rate, it is necessary to compare with rates available to similarly risky investments.

Discounted Free Cash Flow Method (DFCF):

The DFCF method expresses the present value of the business as a function of its future cash earnings capacity. This methodology works on the premise that the value of a business is measured in terms of future cash flow streams, discounted to the present time at an appropriate discount rate. The value of the firm is arrived at by estimating the Free Cash Flows (FCF) to Firm and discounting the same with Weighted Average cost of capital (WACC).

Market Based Method

In this method, value is determined by comparing the subject, company or assets with its peers in the same industry of the same size and region. Most Valuations in stock markets are market based. This is also known as Relative Valuation Method. This method is easiest to use when large number of assets comparable to the one being valued, assets are priced in the market, and there exist some common variable that can be used to standardize the price.

Comparable Company Market Multiples Method (CCM):

Comparable Company Market Multiple uses the valuation ratio of a publicly traded company and applies that ratio to the company being valued. The valuation ratio typically expresses the valuation as a function of a measure of financial performance or Book Value (e.g. Revenue, EBITDA, EBIT, Earnings per Share or Book Value).

This technique hinges upon the efficient market theory which indicates that the price of exchanged securities reflects all readily available information, as well as the supply and demand effects of educated and rational buyers and sellers. In other words, the market is continuously evaluating each company and expressing that valuation in bids and offers for its stock. Therefore, in a perfect world, the market has already done most of the work for you. When using this method, all publicly-traded companies are reviewed in order to identify a peer group similar to the subject company. Once the peer group and proper multiples are determined, the premium paid over the calculated market must be decided based on the variety of factors.

A key benefit of Comparable Company Market Multiple analysis is that the methodology is based on the current market stock price. The current stock price is generally viewed as one of the best valuation metrics because markets are considered somewhat efficient.

The difficulty here is in the selection of a comparable company since it is rare to find two or more companies with the same product portfolio, size, capital structure, business strategy, profitability and accounting practices. Whereas no publicly traded company provides an identical match to the operations of a given company, important information can be drawn from the way similar enterprises are valued by public markets.

Comparable Transaction Multiples Method (CTM):

With this technique of valuing a company for a merger or acquisition, the transactions that have taken place in the industry which are similar to the transaction under consideration are taken into account. With the transaction multiple method, similar acquisitions or divestitures are identified, and the multiples implied by their purchase prices are used to assess the subject company's value.

The greatest impediment in finding truly comparable transactions is the absence of available information on private transactions. In addition to the lack of information on the sales of private companies, the available information in public transactions may be outdated. There is no rule of thumb for the appropriate age of a comparable transaction, although one should be aware of the competitive market at the time of the transaction and factor any changes in the marketplace environment into the analysis. The more recent the transaction, the better this technique, with all other things being equal.

Market Value Method (For Quoted Securities)

The Market Value method is generally the most preferred method in case of frequently traded Ordinary Shares of Companies listed on Stock Exchanges having nationwide trading as it is perceived that the market value takes into account the potential of any Company.

Other Method

Contingent Claim Valuation:

Under this valuation approach, Option Pricing Model is applied to estimate the Value. Generally ESOP Valuation for Accounting purpose is done using the Binomial Option Pricing model.

Price of Recent Investment Method (PORI):

The recent investment in the business is often taken as the base value if there are no substantial changes since the last investment.

Rule of Thumb

Although technically not a valuation method, a rule of thumb or benchmark indicator is used as a reasonableness check against the values determined by the use of other valuation approaches. For each Industry there are certain parameters which can assist in arriving as a benchmark value, provided below

Industry PE,EV/Room
Engineering - Heavy PE, EV/EBITDA, Mcap/Order Book
Mutual Fund AUM1
Insurance NBAP2
Broking PE, EV/EBITDA, Mcap/Sales
FMCG PE, P/BV, Mcap/Sales
OIL PE, EV/ BOE3
Print Media EV/Subscriber
Power EV/MW, EBITDA/Per Unit
Entertainment & Media Mcap/Sales, EV/Per screen
Metals EBITDA/Ton, EV/MT4,
Real Estate Order Book , EV/NAV,Running Project Status & Fair Value of Land Bank Multiple
Transformer Order Book,PE
Textiles PE , EBITDA depend upon capacity utilizatiion Percentage & per spindle value
Pharma Bulk Drugs PE & And New Drug Approvals , Patents
Telephone ARPU, Minute per user, EV/EBITDA, EV/Sales, PEG,EV/Subscriber
Hotels EV/Per Room, P/E & EV/Beds
Airlines EV/EBITDA ,EV/Plane or EV/passenger
Shipping EV/Order Book, Mcap/Order Book
Cement EV/Per ton & EBITDA/Per ton
Banks Price/Adjusted Boook value ,NII5, NIM6, NPA7 , CASA8 per Branch
Cable-Power Capacity,PE & MCap/NAV
Cable-Telephone Capacity,PE & Mcap/NAV Km production per day
Carbon Black PE


1. AUM  Asset under management
2 NBAP New business achieved profit multiple 
3 BOE Barrel of equivalent
4 MT Metric ton
5 NII Net Interest Income
6 NIM Net interest margin
7 NPA Non performing Assets
8 CASA Current Account & Saving Account
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