Company and Business Valuation Models
4 Most Common Business Valuation Methods:
- Discounted Cash Flow (DCF) Analysis
- Multiples Method
- Market Valuation
- Comparable Transactions Method
Market Valuation Method
To determine the value of a publically traded company you can easily calculate their market capitalization (aka “market cap”) by multiplying the company’s stock price (the price of a single share) by the number of shares outstanding for the equity market value. Once you have that value then you adjust for the amount that it would sell for if the company were being sold. The price that buyers are actually willing to pay is not necessarily reflected in the share price. As a result, a company would sell for either a discount (a value under market value) or a premium (which is a value higher than market value).
Discounted Cash Flow (DCF) Method
This is the most thorough way to calculate the value of a company. A classic tool of MBAs, this method has two general approaches:
- Weighted Average Cost of Capital (WACC)
- Adjusted Present Value (APV)
These work by calculating the Free Cash Flows (FCF) of a company as well as the net present value (NPV) of these Free Cash Flows.
Price-to-Earning Multiples: Also known as P/E ratios, Price-to-Earning Multiples compare a company’s market cap to its annual income. This is the most commonly used multiple. To ascertain the value of the company, its current equity value is divided by its recent net income to ascertain the price-to-earnings multiple.
EBITDA Multiples: EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization. Once you have this amount calculated in a standard way, you can factor in the cost of outstanding debts to ascertain enterprise value and then also look at which multiples are used for other companies in the industry to determine equity value. As a multiples method, the total calculated enterprise value is divided EBITDA to determine the EBITDA multiple.
Earnings Multiples: Another method utilizes the earnings multiplier. This method is a good way to assign value to a stable and fairly predictable business that is about to make an IPO. It bases price value on multiples of the business’s earnings potential and so prospective buyers have the ability to translate the purchase price into expected earnings and projected return on investment (ROI).
Comparable Transactions Method
With the comparable transactions method, you are looking for a key factor that helps to determine the valuation. To do this you compare the financials of similar companies and try to find a multiple that closely predicts the valuation. Once you know that, you can use that multiple to value the company being considered.
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