Introduction
Valuation is linked to the investment in some way or other because valuation is the way to determine whether you are paying the right price for stocks or shares. Before investing, it is also essential to check a company’s finances and future growth potential.
True worth can be challenging, especially for a private company. Still, it’s as simple as multiplying the number of shares outstanding by the current share price, and you will be able to determine the market value of publicly-traded or listed companies.
To accurately perform a valuation, you must consider several factors such as past growth, future growth potential, current earnings, future earnings projections, and much more. But how do you find out if the stock of the company you are thinking of investing in or your favourite stock is overvalued or undervalued, or at par?
One of the best ways to assess this is through the process of valuation of a company, which involves taking into account several different factors like industry trends, the strength of the management team and competitors, and future growth prospects before deciding on the actual price you’re willing to pay for your stock.
Here’s how to perform a valuation on any given company, from start to finish.
Although calculating company valuation seems complicated at first, there are several simple formulas that you can use to estimate a company’s worth. The formula used depends on what metrics you’re willing to use. Other valuation methods include Price-to-Earnings Ratio, Price-to-Book Ratio and Price/Sales Ratio. Still, these are best for understanding how a public company performs compared with similar companies (more on public companies below). This guide will focus on three major types of valuations: EBITDA Multiples, Enterprise Value and Discounted Cash Flow Analysis. Keep in mind that these methods assume that the business is operating at its full potential—that there aren’t any hidden issues or problems slowing it down.
A company valuation measures all its assets, liabilities and profits to determine its actual value. Calculating a company valuation will allow you to determine if the business is worth more than others think. It can also show you how valuable a startup is compared with other companies operating within the industry or in a similar business line. Finally, these calculations can give insight into where you might want to take a startup as it continues to grow—showing where a company may be underperforming or thriving.
As stated above, you can use several different types of calculations regarding company valuation. Your choice depends on your information and how conservative or accurate you want your estimation to be. To determine EBITDA Multiples, you’ll need basic financial statements that show revenue, gross profits and net profit margins. On top of that, each type requires its specific steps to get an accurate valuation. The process may also seem daunting because it is fairly detailed and involves using formulas with many different variables—but as long as you follow these instructions step by step, we promise it will be a breeze!
There are several methods you can use for company valuation. Two standard methods are discounted cash flow (DCF) and comparable companies (multiples). The latter uses multiples for valuation, which are ratios that compare one company’s or one segment’s current size or financial performance with another company’s.
For example, if company A is twice as large as company B in terms of revenues, we can say that it is valued at twice as much by investors (or its valuation multiple would be 2). Remember that there is no established rule on what values companies should give through their multiples, so they differ across industries and geographies.
It would help if you researched when determining multiples for your target industry or area. Multiples used most often include:
Another way to look at valuation is based on metrics like operating margin or return on equity, but remember that these metrics don’t consider future growth potential.
This first method of valuation—known as asset-based valuation because it’s based on assets such as buildings, equipment and inventories—is simple. The value is simply equal to total assets minus total liabilities. Assuming that all assets are liquid (quickly sold) and there are no hidden liabilities, we can calculate the liquidation value. To do so, we add up all current assets and subtract any current liabilities; then, we subtract another layer of non-current (long-term) liabilities.
It varies from company to company which method would be right to determine that company’s valuation. Maybe you’re looking at pre-revenue companies or performing the valuation by looking at a similar company. We have mentioned the in-depth guide for all kinds of the company’s valuation process, but first, let’s start with valuation methods.
There are several methods used in valuing companies. One of them is the DCF (discounted cash flow) method, which requires evaluating future cash flows generated by the company and discounting them by accounting for risk. The second method is relative valuation, where comparisons are made with similar firms acquired or merged into other companies.
A third method is transaction analysis, where historical transactions involving similar firms are analyzed to determine their value. And finally, peer analysis consists of data from comparable publicly traded peers as a benchmark for performance metrics like earnings growth rate and P/E ratio. But how would you know which method to use while determining the valuation of a company? For this, we have covered the list of scenarios that you can use to see the valuation.
It can be challenging to figure out how much a company is worth. While you can use plenty of methods, you have a few choices when deciding which approach is best for business. Pre-revenue valuation methods usually involve projecting a company’s future earnings, which means they’ll tend to be fairly conservative and often less accurate than post-revenue approaches. The good news is that all valuations have limitations—there’s no correct answer or one method that’s perfect every time.
One standard pre-revenue valuation method is comparable companies, which involves taking data from publicly traded companies with a similar size and growth stage as a business. For example, let’s say you wanted to know how much investors might pay for a software development company valued at $1 million. You can start by comparing a company’s metrics (like its revenue) with those of comparable businesses that are publicly traded. The biggest pitfall with using another company’s metrics is that two companies don’t necessarily need to be alike in every way for their metrics to be useful for comparison. This method can produce overly optimistic or pessimistic results if it only relies on one or two metrics.
When determining whether or not a company is overvalued, undervalued or at par with its peers, consider several factors such as customer retention rates, customer acquisition costs; cash flow; future opportunities; and return on investment. This will help give you a clear picture of where the business stands within its industry. And remember, just because one method shows that a company is undervalued doesn’t mean it’s time to sell—it’s still important to consider several different valuation methods when deciding whether or not now is the right time for an exit strategy.
For pre-revenue companies, most investors use the multiples method for valuation. This is when you determine what multiple businesses will trade at by comparing it to comparable companies in size, sector and stage of growth. If a company is generating low revenues but is growing quickly, many investors compare it to other businesses in the virtual space.
For example, if XYZ Ltd. launched an app to help people rent their homes on the weekends, you could look at Magicbricks (and its 33% estimated EBITDA margin) or Nobroker. You could also try looking at similar real estate startups like Flatchat or Nestaway.
When you start looking at business valuations in earnest, you’ll see three ways to value businesses. The first is ratios and metrics that use historical financial data, such as price-to-earnings or enterprise value-to-EBITDA. The second approach uses multiples, like price-to-sales or enterprise value divided by revenue. The third way is via discounted cash flow (DCF) analysis, which takes your future expectations for profit and cash flow and discounts them back to today’s dollars.
We have given a beginner’s guide on DCF further in this article. But if you’re just getting started with valuation, focus on comparing similar companies based on their fundamentals—that’s what we call comps. If your company has 100 crores in annual sales and 10 crores in net income, compare its valuation to other companies with 100 crores in sales and 10 crore in net income. This gives you a clear picture of how much investors think those earnings are worth. We’ll show you how below.
When comparing similar companies, you’re mainly looking at two different sets of numbers. The first is valuation multiples—like price-to-earnings (P/E) or enterprise value-to-EBITDA (EV/EBITDA). These multiples tell you how much investors are willing to pay for a dollar of profit or EBITDA generated by your business. For example, if a company is trading at a P/E ratio of 20 and your firm is trading at 25, it tells you that investors think your business has more growth potential than its peers. And that might make sense given where you’re located and what types of clients and projects you attract.
One of these most common methods is using comparable companies’ sales and earnings multiples for your calculations. If you are looking at an Internet stock, for example, you can look at how much Amazon is selling versus how much it earns. What multiple does it get? Is it better or worse than other similar stocks in its industry? Be sure you know the methodologies used in these comparisons when coming up with your valuation multiples. This way, you’ll understand if they are being heavily influenced by one particular company—especially if that company tends to have a very large market share or impact on competitors within its industry.
One common valuation technique involves using comparable companies. The idea is that, while every company is unique, some sectors are very similar in terms of operations, costs and revenues. In theory, if you know what other companies in your sector have been sold for (or valued at), you can use their multiples to come up with an estimate for your own company. There are several caveats with valuing by comps—especially when dealing with private companies—but it’s still a widely used tool. Other valuation methods include price-to-earnings ratios, price-to-book ratios and discounted cash flow analysis.
Also known as net worth, net asset value estimates a company’s assets based on its book value. The goal of performing a valuation is to arrive at an unbiased assessment of your company’s intrinsic worth and compare it to what investors believe your company is worth. This can provide valuable insight into whether you should sell or hold onto your stock for long-term profit potential.
The discounted cash flow (DCF) method is one of two primary techniques for valuing a company. It’s used in private and public company valuation but is more applicable for smaller businesses and startups. The DCF method is based on how much value you’ll get from all future cash flows from owning a piece of the company. To do that, you need to forecast your growth rate and how long you expect those future cash flows to last (or how long your return will continue).
By plugging known financial information into an equation, you can figure out what your share of those future cash flows is worth today. While many other valuation methods have their unique strengths and weaknesses, none really outperform DCF as far as accuracy goes. That said, it’s important to remember that many judgment calls go into performing any type of valuation—and they often vary depending on whom you ask. For example, companies with high uncertainty or risk often require higher rates of return because investors don’t want to commit money without knowing if they’ll get paid back.
This approach values a company by multiplying its current market price by its total number of outstanding shares. Market capitalization is also known as market value, market cap, or simply value.
The other elements are used while calculating the valuation of a stock or company.
The price-to-earnings ratio, or PE ratio, is one of the most commonly used ratios in determining if a company is overvalued or undervalued. It’s calculated by dividing the current stock price by annual earnings per share. This can be compared to other companies in your industry and historical averages for your industry. A higher PE means that the stock is more expensive than other similar stocks, which can mean it’s overvalued; conversely, a lower PE means it’s undervalued.
There are no hard and fast rules for valuing a company. However, some generally accepted guidelines include earning per stock (P/E). Earning per share (EPS) is determined by dividing net income by the weighted average number of shares outstanding. A stock trading at Rs 30 per share with an EPS of Rs 1 would have a P/E ratio of 20x earnings. This means that investors, in the aggregate, are willing to pay 20 times its current annual earnings for ownership in that company.
The price-to-sales ratio (PSR) is one of several multiples used to value a company. It’s calculated by dividing a company’s share price by its sales per share. The higher a PSR, the more expensive a stock is relative to its sales level. A PSR greater than 1 indicates that you would pay more for each dollar in sales than you would if it were lower.
This ratio is one of the easiest and simplest ways to arrive at a valuation number. Book value is generally considered to be net worth minus intangible assets. For example, if a company has 100 lakh in net worth but owns 10 lakh in patents that can’t be sold separately, its book value would be 90 lakh.
This acronym stands for earnings before interest, taxes, depreciation and amortization. EBITDA is often used in company valuation and may also be referred to as earnings before interest and taxes. EBITDA measures a company’s pre-tax profitability by taking into account revenues minus all operating expenses (including depreciation).
You’ll need to calculate its valuation to determine if a company is over or undervalued. The valuation formula follows: Market Capitalization + Debt – Cash = Enterprise Value. For example, if TCS. has a market capitalization of 500 lakhs and 120 lakhs in debt with 250 lakhs in cash, then its enterprise value would be 370 lakhs (Market Cap + Debt – Cash). Next, compare that number to similar companies in your industry. For better clarity, let’s understand the example of both over and undervalued companies.
When making decisions on stocks, it’s important to remember that every company is subject to its own valuation. While some stocks may be considered undervalued or fairly valued, others are highly overvalued. Paytm and Zomato are two prominent companies that have been plagued by overvaluation—in fact, Zomato has depreciated more than 50% and Paytm has lost more than 60.26% valuation since the IPO. That said, high market value isn’t always an indicator of high worth, meaning you should always consult other metrics when attempting a company valuation analysis. For example, if you believe Paytm is truly worth 19 billion dollars, then you might want to consider the current valuation, which is less than $1 billion.
By using company valuation analysis, you can find out which companies are undervalued so that one can invest in them. Some examples of undervalued companies include Deepak Nitrite and IOL Chemicals and Pharmaceuticals. Starting from Deepak Nitrite, one of the leading chemical intermediates companies, you look at the company’s price chart in the last 1 year. You will see a CAGR of 166.5% and a PEG ratio of 0.26; not only this company has shown approximately 62% over the last 3 years.
Similarly, IOL Chemicals and Pharmaceuticals is among the few leading companies in bulk drugs; the company is also the largest producer of Ibuprofen, with more than 35% market share. When you look at the CAGR of 3 years, you will find the 43.6% return in the price chart of this company; the company has shown a sales growth of 39% and 326% profit growth in the past 3 years.
Present value is one of several ways analysts look at a company’s valuation. It looks at how much money it would take today to equal Rs. 1 tomorrow, based on its expected earnings and growth rate. To determine the present value, you can use an online calculator or formula that uses variables like periods, interest rates and future cash flows (also known as discounted cash flow).
This basic equation calculates present value by plugging in estimated growth rates: Present Value = (E / r)^(1/t) + Cash Flow N. The E/r part refers to your expected rate of return on your investment. Use 15 per cent if you’re estimating an IPO with minimal risk; 10 percent for a mid-range startup; and 5 percent for mature companies with stable earnings.
The N represents your total number of years. Plug in 1 if you want to know what it takes to be worth Rs. 1 right now, 2 for two years from now, etc. The Cash Flow section represents all your estimated income over those periods. If you don’t have actual numbers yet, just estimate them—you’ll get more accurate once you have real data from real customers paying real dollars into your business bank account!
One easy way to evaluate is by looking at how much money an investor thinks that company will make in five years. That investment logic is called future growth potential, worth 35% of your company’s value. To figure out what investors think your company’s value should be, add up how much they think you’ll earn in five years and divide that number by 1 minus your cost of capital (which we’ll explain below).
The result will tell you roughly what your business is worth right now. For example, if investors think you’ll have $100 million in sales in five years and your cost of capital is 10%, then they’re saying your business is worth $1 million today.
Conclusion
Valuation is an important topic in finance and accounting. It refers to determining the worth of an asset or company, which ultimately helps financial experts determine whether an investment is too risky or not. In real life, valuation isn’t often as straightforward as many experts make it out to be because we must take into account all of these variables over time. However, these techniques are simplified for students taking business and finance classes to learn how valuations work in theory before applying them in practice later.
There are two primary ways companies are valued. The first is based on book value. Book value (also known as shareholders' equity) refers to how much an investor would receive if all assets were sold, debt was paid off, and all liabilities were satisfied. A low book value indicates that there's substantial room for growth in a company because its assets are undervalued.
Take whatever interest rate you'd get from a bank for a loan or line of credit (say, 5%) and subtract from it whatever return investors expect from investing in stocks over time (say, 7%). So if you can get a loan for 5%, but investors want 9%, then your cost of capital is 4%. If that doesn't make sense yet, don't worry—we'll show you some examples later on. It might seem counterintuitive to use what could be considered future profits as part of your valuation formula today—but remember that these numbers are also based on expectations about inflation and other factors.
To value a private company, you have first to know what it's liquidation value is—that is, what its assets are worth if it were to shut down today and sell everything off. To get there, you need to know what all those assets are worth individually and then add them up. You also need to estimate what sort of revenue stream that business could generate going forward—how much cash would it make? And at what rate? Once you have those two figures (assets and cash flow), simply subtract one from another and voila! You have your valuation for a private company.
To understand how equity is calculated, you first need to understand what an asset and a liability are. An asset has value, such as money in your bank account or stocks you own in TCS. A liability costs money, such as your credit card balance or mortgage payments. So when we look at equity, we look at those assets minus any liabilities. So if you have Rs one thousand in your bank account and no debt, your net worth would be Rs. 1,000. If you have Rs. 100 in cash and Rs. 900 in debt, then your net worth would be - Rs.800. Let's see how that breaks down into equity value. Equity value = Assets – Liabilities Equity value = 1000 – 900 Equity value = 100 This means that if you sold everything you owned right now, your equity would be Rs. 100. So why do companies perform valuations? It's a very important step for determining how much money should be raised during an investment round. For example, let's say someone offers to invest Rs. 500k in exchange for 50% ownership of your company. What they're saying is they want to pay Rs. 250k for half of your company because they think it will be worth twice as much (Rs. 500k) once it grows.
If a company raises $1,000,000 in funding, they have issued $1,000,000 worth of stock, but they only have $1,000. Equity is an at-risk investment—the company can lose every dollar invested by investors, and they will be last in line to get paid back after any other creditors. In that way, equity is inherently risky. Conversely, capital is money that has been loaned to a company (like debt) but will be paid back before equity holders are ever repaid. There are some other key differences between these two types of financing as well.
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.
Open Demat Account &
Trade @ Rs15 per order.
“Filing of complaints on SCORES – Easy & quick”
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.