From the December 2020 IAFEI Quarterly Bulletin
By Carlos Eduardo Sau Escobar, President IMEF Pueblo Group
2020 is the year that took us by surprise, in which the crisis caused by the COVID-19 pandemic has caused everything to change. Perceptions and needs, and, of course, the value of a company could also be in question. But it also presents opportunities now and in the future.
This perception of the value of a specific company can be explained by multiple factors, but valuations will likely become more challenging in times of a pandemic. Dear reader, an important point that we must keep in mind before continuing is that value is not equal to price, because in general, the company has different values for different buyers, and for the seller, the value should not be confused with the price, which is the amount of which the seller and the buyer agreed to carry out the transaction for the sale of a company.
Therefore, the valuation technique of a company is a fundamental exercise to understand not only its competitive position in the market, but its share and its sustainability.
Today different decision-makers need to know how much the value of a company has changed with COVID-19. Therefore, valuing a company becomes more than ever essential, regardless of the valuation method chosen, it becomes a process in which they must, while quantifying the current elements that constitute the company and the competitive position it holds within your sector, must also consider future expectations of wealth generation.
Now more than ever it is important to distinguish the companies that have the financial capacity to withstand this crisis from those that will have to be sold to avoid bankruptcy.
However, today we find ourselves in a situation in which , sure that our scalar values have changed, many of us today value intangible issues that at the beginning of the year we barely granted any value or even did not value at all.
The impact of the coronavirus some goods, not only tangible but intangible, has taken a toll on practically the entire business fabric, with the exception of certain sectors that the crisis have given additional value such as food, the health sector, digital entertainment. And all those who have adapted their production to the new needs of the consumer.
In these times we can affirm that the health crisis has caused the value of everything to be in question, positively or negatively. Today, an updated valuation of the business projected for the future, can help make strategic decisions for business liability or, even to take advantage of new opportunities.
Given this, how do we assess a company in times of the pandemic? What valuation methods are the most common and which one should we use now?
Although it is true that financial valuation methods seek to determine the value creating elements to specify a value range that serves as support from informed opinion of what the company can be worth, the important thing before applying the method is to know the needs to obtain the value of a company since these can be several, by purchase and sale operation, to compare the value obtained with the price of the share in the market, for a settlement . That is, depending on the purpose of the valuation and the parties involved, the value based to be used may be different and depending on this, and the final result will be different.
Three of the most used methods to value a company are the following:
- Discounted cashflows: focuses on income and the generally accepted method of value a company. The expected net cash flows in the next five years of generally calculated and the residual value is estimated at the end of the period. likewise, an appropriate discount rate is applied based on various risk premiums.
- Multiples: this is a market approach in which comparative parameters of transactions of similar companies are used, both in the sector and in size.
- Net book value: but which the company is valued by the difference between the sum of the book value of its real assets and the sum of the book value of its enforceable liability.
Before determining which one to use, especially in times of the pandemic, in the following, let’s see the advantages or disadvantages of the three most used methods. These methods have enormous advantages and disadvantages but an important point to evaluate is that in times of crisis and especially in these times of the pandemic, with uncertainty, in order to be able to choose the most realistic. You paragraph it is important to know and use the correct technique. The most common is to use a combination of several valuation methods, such as the application of the cash flow discount method together with the comparable multiples, and take special attention to the projection of business as well as the importance of to the intangibles of the company, powerful factors for its valuation.
Valuing a company is a fundamental task to sell your company or not your market. Very few companies do it.
On the other hand, as we have stated, no valuation method is exactly perfect for each situation, so knowing the characteristics of the company and the market, especially in these times of crisis, will allow selecting the method that best suits the situation. This is why it is important to have the data validated and its coherence with this strategic approach as well as to know the intangibles of the companies to make a reliable projection and therefore an objective assessment.