How to value a company using net assets - MoneyWeek Investment Tutorials

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Closed Caption:

yeah
yeah
yeah
so welcome back to my video series on
valuing companies those of you who've
seen my introductory video three ways to
value a company have been asking me can
I go a little bit further and take on
one of the techniques by illustrate very
briefly in that video response to those
queries here is my tour of one of the
three techniques i introduced in that
initial video now quick recap those
people haven't seen the video and
scrambling around wondering where it is
called three ways to find a company it's
very basic and in it I described
basically two approaches to ballet
company and the second one split into
two give you the third method so in that
video I talked about a bottom-up
approach this is the objective here way
is if you're a predator about a buyer
company you want to know what it's worth
how much should you pay office or to pay
as little as possible because you
justify the price in some way sellers
have to justify their price as an
investor these can be useful reference
techniques for looking at you know am i
buying a share at the right price level
and bottom-up is going to cover today in
a bottom-up is basically what it sounds
like there is a way of saying what one
way to approach value and company would
presumably be to get hold of its balance
sheet that's the statement of net worth
if you like start there and maybe make a
few tweaks to get to what I think the
company is really worth on the open
market that's what i'll be covering just
a moment was a reminder not the only way
to go about it okay
there are what I could loosely call
top-down approaches the value in
companies all right back can be split
roughly speaking into two types of
techniques there's using multiples and
there's DCF now probably rather fast
because I may well take on these videos
but essentially you can use things like
pina ratios and price-to-sales ratios to
sort of extrapolate a value for a
company that you're looking at all right
and you can use a single discounted cash
flow which is quite a meaty topic
LT may take on another video there
request for that and that is projecting
future cash flows bringing them back to
today's money using a discount rate
right fairly hairy stuff organized these
days take the almost the simplest of
those three one two three
i'm gonna call this the assets approach
so that's your three techniques assets
multiples in DCF are gonna focus over
here and just ask the question how to go
about that right well I'll give you a
hint just now this is gonna be a rough
going i could say a lot more but just
give you a flavor of how this works
ok now where would you start you'd pick
up a set of accounts and you'd say what
is the statement of net worth as far as
the accountants are concerned all orders
and signed off
it's called a balance sheet right now
for those people who are thinking one
has a balance sheet i would urge you
strongly to look at my video
not surprisingly entitled what is a
balance sheet and that's a really good
starting point
what I'm about to say because in that
balance sheet you'll find an estimate
using accounting rules of what the
company's worth so i'll call that net
assets and that might be lets say a
hundred million already big company and
says a hundred million sterling now you
might say well there we go that's what
the company's worth I mean the balance
sheet says a hundred million now sets
that signed off by auditors and so on
its official documentation so that we
are the company's worth a hundred
million and it had 100 million shares in
issue you could say each one's with
pound hundred million over a hundred
million life isn't quite that simple
why because balance sheets are a good
starting point that after all they
verified hereby set of orders and blah
blah blah but there are problems with
them they don't represent what you
actually paid by the company in the open
market
ok why not well first of all you need an
up-to-date now that statement if you
just pick up without accounts published
the last time the company did its full
set of accounts are probably several
months a day already even leaving that
problem to one side supposing you can
get a balance sheet was right up to the
minute you still wouldn't rely on it
hundred percent as the basis of saying
that's what the companies were so i can
look at the share price and and judge
whether I'm overpaying under bank was a
predator I can judge whether on to pay
that price a bit more or less so on
ok so why well the answer is basically
the analogies are sort of incomplete and
they're prepared using accountants rules
that gives them one or two failings when
it comes to really valuing the company
in today's market terms what all those
right well you could have assets that
are either missing or biology or assets
that are in the balance sheet as part of
this net asset hundred million but
overstated
ok so you end up with a set adjustments
and they could be positive or negative
what i mean by that well it may be that
the company has written officer and
assets completely following the
accounting rules that you think have
some value as a predator
ok you think that you have some value
you'd have to tweak up the bigger in the
villages take out of that all right now
someone buying company you want to pay
as little as possible but understand the
back of your mind you're thinking well
those are worth something and why don't
they appear in the books
okay hold patents licenses that kind of
thing
alright an equally you might want to
knock some off my same i'm knocking five
million off at $TIME hundred million
asset figure because i think the stock
figure in the balance sheet is
overstated
there's no way is gonna be worth that
much to me the buyer or I think the
receivables figure is optimistic
ok so the little adjustments as a
predator you might start to make to get
to a true a figure of what you think the
company's worth by the way you might
enlist the help of accountants doing
doing what's called due diligence in the
corporate finance department to help you
with this exercise if it starts to sound
a bit technical
ok so you're gonna go through the assets
making adjustments another example we
may need to make a positive or negative
adjustment is accountants often leave
assets in the balance sheet it was
called historic cost a date land and
buildings for example you might want to
get some surveys in giving update
valuation and change
it has a very accordingly ok on the
other side the reliability adjustments
just giving you a real flavor this
ok positive or negative so what I'm
saying is you'll end up with the revised
number based on making those adjustments
to be more than hundred million or less
than women while adjusting could be what
imagine you're buying a 2-pack over for
example
hey what's the liabilities and may not
been fully captured on the balance sheet
might your adjustable legal claims ok
accountants have a habit of saying well
you can't record a legal claim against
those in assets unless it's reasonably
certain impacts reason you well know
ok but as a buyer be thinking well
crikey i think i'm buying this thing I
load a legal claim suddenly hit me
I've got to cover them that we my
problem then ok so you might make you
know downward adjustment by pumping in
some more liabilities there could be
hidden nasties that are not reflected in
that number you're worried about the
buyer or even as an investor ok because
these so-called contingent liabilities
to use the accountants language or a
mattress on judgment judgment
alright so the point is it superficially
the assets approach to valuing companies
is quite straightforward in the sense
that you take a reasonably reliable
starting figure tweaking up all down
ok according to what you think assets
are worth of what you think the true
liabilities position is an arrival a
revised number you know as a predator
you want to be as low as possible as the
person selling this business you always
want to be as high as possible when you
get into a little bit of allergy and
negotiation
alright but it's not as straightforward
as I made it sound because you know some
of these adjustments you need to have
your wits about you and that's where in
practice people do buy and sell
companies tend to bring experts in to
help in the form of Community Chest
accountants working corporate finance
department investment banks and so on
and that just gives you a flavor and you
don't even stop their writing company's
top it's not easy there's no quick
method you get a number 220 million and
then you might think well is this the
right approach the business on buying
looking at as an investor what sorts of
businesses would you apply
an asset-based approach to others
including the name businesses with a lot
of assets while those well you could be
looking at a property investment
companies for example investment trust
companies they sort of approach works
better for those than it would for
internet or software firm where frankly
there's much in the way of NASA's to
start with
ok so now this approach is one approach
depending on the type of company almost
certainly go on and look at multiples
and look at DCF to give you the biggest
range of possible valuations the company
to open negotiations or as an investor
to give you some reassurance that the
company is worth what other people seem
to think it's worth
ok so they have it a fairly quick guide
to one of the three ways of potentially
arriving at the correct inverted commas
value for a firm hope you enjoyed that
video and in future videos I'll take on
a couple of these other areas for those
people have asked about