Hi all, I am interested to see what, if any, errors or problems people commonly see with business valuations, either theoretical or empirical.
One of the most common errors I see is the double-counting in the assessment of
I welcome any other thoughts and hope this discussion is helpful.
Common Valuation Errors
Answers
Randy:
I have done a lot of valuations in my day as
Next up, the methods of valuation. Comps/multiples and DCF modeling are both popular and both hugely flawed for all but the most established companies. Unless you are in an industry where there are a lot of private company exits and their numbers are readily available (this does not describe many industries) it is very hard to find true comps. You can rationalize your way into many comparisons but at the end of the day your buyer determines your price based on their thoughts on your value unless you have multiple bidders.
I have worked for a number of very large public companies and their margin of error on current year budgeting, much less 3 or 5 year forecasts, is very large. And these were companies with unlimited budgets and the most sophisticated modeling tools you can find. For private companies, which tend to be smaller, it is truly a crapshoot. So DCF, even before we talk about discount rates, is highly subjective with high variance.
So what does it all mean? Simply that valuations are more art than science and that there is no right answer. There is, however, supply and demand, and that determines real market value. But until you are in a sales mode with one or more viable buyers, anything you model will be just numbers on the page.
I find the most valuable aspect of the process is the process itself. I know I will never come out with the "real" number a year or three out, but it invariably teaches me things about the company and its economics - which is very valuable indeed.
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One of the ways that we hedge the margin-of-error is by running a simulation similar to that of a projected hurricane path where you have the forward looking cone that gets wider and wider as the landfall date is further out. We apply a similar type of strategy by running our DCF based on three different scenarious (downside, base, upside). We allow the the DCF to run it's course and supply us with the outputs and then we argue around the weighting of the various cases.
Yes, there certainly are many subjective issues and I totally agree that valuation is both art and science. All we can hope for is to get the "science" part as fundamentally sound as possible. Since valuation is such a permeating theme in the business and regulatory environments. we have to have some way to do it! In plain terms, "value" is the highest price a purchaser is willing to pay - which we never know until after the fact. All we can do is estimate.