Valuing any good and/or service has always been fundamental to all cultures and civilizations. And valuation methods have long been developed to try to be as accurate as possible.
However, the valuation of a company, by its very nature, cannot be contemplated as the result of the application of an exact science, and the conclusions reached are, in part, subjective and depend on individual judgment. Consequently, it is generally accepted that there is no standard valuation formula that is indisputable.
The valuation of a company is defined as the process of quantifying the elements that make up the company’s assets, its activity, its future potential, its goodwill or any other business characteristic that is susceptible to valuation.
Thus, although there are several objective valuation methods and criteria, every valuation exercise involves an important component of subjectivity. In this scenario, the crisis we are currently experiencing gives a new dimension to the subjectivity inherent in any valuation.
All this leads us to distinguish between value and price, the value of a company being an estimate, within a reasonable range, of the value of its assets, its situation, the method used to determine the value, and the economic situation at the time the valuation is made. In other words, the value is not an absolute fact, but due to its subjectivity, it could be considered as an opinion and, consequently, the value of a company, calculated through the application of a method, may differ from the price that a potential buyer is willing to pay and the price that the seller is willing to accept, since strategic, financial and other factors, unknown in most cases by the valuator and which, even if they were known, might not be susceptible to objective valuation, have a determining influence on them.
As Antonio Machado said, “only fools confuse value and price”.
But what are the most commonly used valuation methods and how has the crisis affected their objectivity?
The market consensus distinguishes mainly between two groups of valuation methods: Static criteria and dynamic criteria. The former are those that attempt to determine the value of a company at a given time (here we distinguish between book or liquidation value or the most commonly used valuation methods such as valuation by comparable multiples of both similar transactions and comparable listed companies).
The second, the dynamic ones, analyze the company as an operating entity and therefore are the ones that best show the drivers of the company’s value. Within this group of valuation methods, the discounted free cash flow method stands out.
In the current scenario of economic impasse, static methods lose objectivity, since they perform the valuation at the worst possible moment, with the known risk of the expiration of the crisis, since it will not last forever. For example, in the comparable multiples valuation method, it is difficult to choose the multiples to be used, since in 24 months, the picture has changed completely, so there is hardly any relevant information to use in the valuation. Therefore, in times of crisis such as those we are currently experiencing, the discounted free cash flow method may be the most appropriate, although it still has great uncertainties, the main one being the calculation of the residual value, which can represent up to 70% of the final value of the company. Another great unknown to be resolved in this method is the discount rate applied, which entails a great sensitivity to changes, however small they may be; variations of 50 basis points can change the result of the valuation by a very high percentage. To all these uncertainties must be added the not inconsiderable risk premium that must be applied in these times.
After pointing out the disadvantages and risks of using the discounted free cash flow method, we have to take a stand in its favor, since the application of this method can favor the implementation of financing plans, which is so difficult to achieve at this time.
To correct some of the problems that this method may have, we must not forget that in times of crisis it is essential to extend the time horizon, and to take into account more than ever the economic expectations of the sector, the cost structure of the company and its flexibility.
In conclusion, we can affirm that in the current scenario of constant change and variation, dynamic methods prove to be more appropriate, since they allow us to know the value of a company more accurately and precisely, even with the risk of taking into account hypotheses that may not be fulfilled in the end. Static methods, on the other hand, offer greater reliability in terms of the parameters used, especially in the case of the multiples method, since they do not involve forward-looking assumptions, but rather the value at the date of analysis, but in exchange they give a less precise valuation, due to the changing and evolving nature of the market and the economy. Colloquially, we could say that static methods offer a snapshot of the company in the foreground, while dynamic methods offer a general snapshot.
With the crisis, it is not the theories and methodologies that change, but the circumstances, perceptions and parameters. In this method, the key issues are the viability of the company and assumptions about future performance. Neither the fundamentals nor the most widespread methods change, but the way of applying them, where the subjectivity of the present moment plays a determining role.
Broadly speaking, we could say that the analytical methods used to value a company are the same in times of prosperity as in times of crisis, but with greater emphasis on the rigor and seriousness with which we apply the analytical concepts.
