3 ways to value a company - MoneyWeek Investment Tutorials

Valuing a company is more art than science. Tim Bennett explains why and introduces three ways potential investors can get started.

Visit http://moneyweek.com/youtube for extra videos not found on YouTube.

Related links…
• How to value a company using discounted cash flow (DCF) - https://www.youtube.com/watch?v=jfcRU...
• How to value a company using net assets - https://www.youtube.com/watch?v=rV68z...
• What is a balance sheet? https://www.youtube.com/watch?v=DuKEc...


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Closed Caption:

yeah
yeah
yeah
welcome to this week's money week video
and this week I want to deal with a
topic that's a few people have asked
about
it's a pretty big meaty topic it is how
do you value a company
obviously that's something that
predators want to do before they take
over a target to use take over language
and it's something that investors should
have an interesting when you're buying a
share you want to be looking at you know
am I getting good value for money or not
and how do i think about the value of a
company
well to cut to the chase how do you
think about the value of any asset take
a house for example arguably there are
three ways you can decide whether or not
to buy a property you could do a little
bottom up
estimation of what it would cost to buy
the land and build the thing that will
give you a number
ok you could look at the price of houses
nearby
they won't be identical but that will
give you some field for the one you're
looking at
or you could say actually maybe a
property is only worth what someone is
prepared to pay to live in it so you
could sort of do a calculation of all
the future rent that the asset might
generate and then bring it back into
today's money terms using a technique up
another video called discounting all
right you little bottom up bricks and
mortar approached the house next door
approach and the value of a rental
perspective approach
now those won't necessarily be the same
number of your range
ok and then as the buyer you negotiate
the lowest price possible as a seller
you want to negotiate the highest price
possible
well what's that got to do with today's
topic companies can be valued using a
sort of similar three-pronged approach
if you like this video
all I'm going to do is outline those
three approaches and then maybe in
future videos if there is demand out
there
I can take that on a stage further so
how do you do it right
well fundamentally it's an art rather
than a science
all right there numbers involved the end
of the day a company like a house is
only worth what someone's pants
pay for it and now i want as little as
possible for the seller you want to get
as much as possible so the idea is to
establish a range against a range to get
the negotiation going in and obviously
sellers look to achieve that are going
to the range and buyers look to keep the
bottom end of the range
how's it work well three approaches
remember what I said about the house
just now
all right well he was a little bit
loosen fast with the facts but those
three approaches i described also
describe the way that you can go about
valuing an entire company
ok one of them is what's called the
asset-based approach now in this video
is going to introduce the language
I'm not going to go into this any detail
but essentially you could take a
company's balance sheet as a starting
point
you're not sure we all know the balance
sheet is see my video popular one
what is a balancing ok you could start
with the company's biology to look at
the list of assets make some adjustments
according to as a buyer whether you
think there is a store not come up with
a kind of asset based evaluation but you
just stop there
no okay because chances are you're not
buying the company to simply wounded up
and flog off the assets
chances are you're buying it I guess a
predator for example and invest you're
looking at the longer term so we're
looking at where you can squeeze out of
it
so another approach would be the house
next door bridge ok this is going to
break some water approached the house
next door is called a while call it arm
ratio based and if there's demand we can
cover these other videos
ok you may come across this one if you
have done a bit of this stuff before
ratio base is essentially saying well
let's take a similar companies so ones
from the sector that this company
operates in let's look at something like
their PE ratio for that price to sales
ratio again
topics like
or in other videos what is a p/e ratio
was the price to sales ratio
ok and let's see if we can come up with
a sort of comparative number for the
company that we're looking at all right
arm now very very simply very very
simply this works on this off premise
you know the P ratio is the relationship
for example putting the current share
price for company and one year's
earnings
alright so are you know if you've got
sort of let's say a p/e ratio of 10
ok you can rearrange this formula you
like about the maths and say well the
value of a firm is equal to just
multiply that out 10 times earnings
all right if you're into math you can do
a bit of rearrangement
ok so pays it was 10 times earnings so
what you can start that they can do is
say well you know if I can come up with
the right
earnings figure and if I think that 10
is about the right multiple to apply to
the firm i'm looking at based on other
similar companies i can start to come up
with a value for pay
that was a little bit quick and dirty
but you still may get the basic idea
from that ok
and the third and biggest and junkies
method
ok is what's called discounted cash flow
DCF that's the kind of what's your
property worth looking at its rental
income in the future time approached
again not going to cover that in this
video could do an entire video on that
quite comfortably
that's the idea that what you actually
want to do is to forecast the earnings
and cash flows that the company will
generate looking into the future and
then bring the mac today's money using
what's called a discount rate
ok and I do cover that in another video
in outline terms
okay so there we have it want to
introduce the ideas will have done this
but there are several ways you can buy
your company and there's a Predator is
vital
ok so you don't ever pay for it as an
investor is quite important
- okay so those three methods are
asset-based bottom-up take a balance
sheet see what the company's worth a
balance sheet one of you make some
adjustments based on what you think
assets and liabilities might really be
worth the ratio based approach that says
let's look at similar companies get a
handle on a typical multiple for the
sector and then take a number for the
company we are looking at i multiplied
to get the price that can be done using
the p/e ratio the price to sales ratio
depends on the company panel sector and
the third approach is a biggie
discounted cash flow and that's used in
many many many situations
ok it's unusual to just do one of these
quite often you find it two or three of
them bc that's the hardest of all of the
most amount of work
projecting cash flows into the future
discount the back to get a price or
value today
all right and then armed with those
different numbers because these could
easily throw out three of numbers
hopefully not totally divergent you then
begin
if you're buying a company the
negotiation on what you're actually
going to pay based on the range of these
three techniques just generated hope
that's been useful
see you in the next video