Are you going to buy shares in a company, or perhaps sell existing shares? Then you need to know what a reasonable price is. In this article we describe different ways of carrying out a company valuation.
The methods we go through can be used to value companies, whether they are unlisted companies or listed ones:
- When it comes to unlisted shares, a company valuation may be needed for a buyer and seller to agree on a price at all. It is also common in the division of matrimonial property, estate inventories and court disputes.
- For listed shares, a valuation can be carried out to assess whether the market is overvaluing or undervaluing the share.
Different methods for valuing companies
There are several established methods for valuing companies:
- Relative valuation – value based on what similar companies have sold for
- Net asset valuation – based on the net value of assets and liabilities
- Earnings valuation – value based on historical profit via an earnings multiple
- Cash flow valuation – valuation based on estimated future cash flows
- Liquidation valuation – when the company is to be wound up
We will shortly go through each of these different types of company valuation.
Value it yourself or hire an expert?
If you mostly just want to satisfy your curiosity, you can value a company yourself, at least with a simple version of net asset valuation or earnings valuation.
But if you are going to buy or sell shares (or even an entire company), or if the valuation is being carried out in connection with a divorce and division of property, a court dispute or similar, then you should definitely get a professional company valuation.
For one thing, a skilled valuer knows how assets and profit should be normalised for the calculation itself to be correct. That is, adjusting for market value or for things that are not representative of the business. For another, the valuation itself carries a weight that can earn respect from your counterparty or be heeded in court.
Let us now look at the different methods:
Relative valuation
Relative valuation means examining what other similar companies have sold for in the past. It is one of the simplest types of company valuation.
If, for example, ten companies have been sold recently, you can take their average price or median and possibly adjust it with a discount or premium depending on what the business looks like.
This gives a good indication of a suitable price, especially if it concerns a local business, for example a grocery shop or a restaurant comparable with the company in question.
The only problem with relative valuations is that there is rarely enough data. There may not have been enough transactions, or the information is not available.
Looking at what listed companies are valued at and applying that to unlisted companies is not advisable either, as listed shares are usually valued considerably higher.
Net asset valuation
Net asset valuation is a method that can almost always be applied, and it is also relatively simple. It is based on the net value – the difference between the value of assets and liabilities in a company.
Put simply, it is equity. To get a quick idea, you can therefore look for this item in the balance sheet.
For it to be correct, however, you need to start from the net asset value. It is based on market value, not book value. For example, a lorry may be worth zero kronor on paper because of depreciation, but in reality it is worth several hundred thousand kronor.
Net asset valuations are good when you want a quick and conservative valuation method without speculation.
The method is well suited to companies that are not profitable, or if you are carrying out what is known as an asset transfer (an asset deal, in Swedish inkråmsöverlåtelse).
It does not, however, take account of either profit or intangible assets.
Earnings valuation
Earnings valuation is the most common way of valuing companies. A multiple of historical profit is often used to arrive at a value.
For example, you can take the historical profit for the last three years and possibly weight it to give the most recent year more importance. You then multiply the profit by a multiple. Hence the term multiple valuation, which you sometimes hear. The multiple is often between 3 and 5 times profit, but it is set individually for each company.
The method is well established and considered robust, even though some speculation is needed to judge a suitable multiple. It may depend, for example, on how dependent the business is on its owner, how scalable it is and how large its potential is.
People also talk about multiple valuation of listed shares to assess how a share is valued over time or compared with other shares. This is then done with so-called valuation multiples such as the P/E ratio, the P/S ratio or the P/B ratio.
Cash flow valuation
Cash flow valuation (also called DCF valuation) can be said to be a variant of earnings valuation. But instead of using historical profit as the basis, an estimated future cash flow is used to calculate what is known as a present value. That is what the company is worth today.
The advantage of this method is that it is also possible to value companies that are not profitable, for example a startup.
Unfortunately it almost always becomes very speculative. For one thing, the cash flow for the coming years has to be estimated, which is close to impossible in all companies except possibly very large and stable businesses.
For another, you need to decide on what is known as a discount rate at which the present value is to be calculated.
The method is so uncertain that two professional valuers can reach completely different conclusions about the value of one and the same company.
Liquidation valuation
Finally we have liquidation valuation. This method is used to value companies that are to be wound up, often in connection with bankruptcy.
Put simply, it is a kind of net asset valuation. The difference is that a large discount is applied because the company has no standing in the market. “Lack of marketability”, as it is called.
In principle, it means that the assets are sold as well as possible, which is often in a hurry. The liabilities are then repaid and the winding-up costs are deducted.
Which valuation method should I choose?
Which way of valuing companies is best depends entirely on the situation – and what type of company it is. Different company valuers also have their favourite methods.
Generally speaking, an earnings valuation in which a multiple is applied to historical profit gives a good indication of the company's value. If the company has significant assets, for example equipment or a fleet of machinery, it can usefully be combined with a net asset valuation.
If the company has no profit, the valuation can be based entirely on the net asset value. The same applies if the company is to be liquidated (regardless of any profit), but then at a discount.
It is also fairly common for company valuers to value the cash flow with a DCF valuation. However, this method is far too speculative to give a reliable result.
Nevertheless, cash flow valuation may suit some startups when none of the other methods is applicable, that is, when there is neither profit nor any assets to speak of.
