企业金融专业代写 CHOOSING AMONG DIFFERENT

CHOOSING AMONG DIFFERENT VALUATION APPROACHES

企业金融专业代写 A frequent response is, “OK, discounting is the way to go. But my customer doesn’t understand discounting. He only understands 

The Problem  企业金融专业代写

Students of corporate finance frequently ask, “Why should I use the discounted cash flow valuation method when there are other easier and more popular methods available?” The answer has to do with the relative strengths of both the method and the analyst.

First, consider the range of valuation methods, which can be grouped into three general approaches:

1. Approaches based on accounting

• Book value per

• Tangible net worth per

• Replacement value of equity per

2. 
   

   Approaches based on earnings

   
   

• Price-earnings multiple. Widely used by investment bankers; based on an analysis of comparable

• Stock price to Buyers of commercial real estate often value properties at five times operating income; some insurance companies may use this rule in quickly valuing securities.

3. 
   

   Approaches based on discounting cash

   
   

• Discounted cash Used extensively by corporations to evaluate capital projects, and by investors and financial intermediaries to evaluate financial securities such as bonds and equities.


• 
  
  
  
  • Dividend-growth model. A mathematical summary of discounted cash flow based on an assumption of a constant growth rate of dividends infinitely. Very widely used.
  
  
  
   
  
  
  
  • Dividend capitalization model. A mathematical summary of discounted cash flow assuming zero growth in dividends in the
  
  
  
   

  Most analysts would readily agree that values based on accounting tallies often have little correspondence to real market values. First, accounting tallies describe history, not the future. Second, there remains enough latitude in the choice of accounting policies that managers can significantly influence the magnitude of accounting values.

   
  

  The usefulness of approaches based on earnings multiples is somewhat more problematical. Sophisticated analysts are observed using these approaches, so the suspicion is that multiples must be acceptable to use. Nevertheless, there are a number of significant pitfalls in these approaches:  企业金融专业代写

  
   
  
  
  
  • Vulnerability to accounting cosmetics. Most of the criticism of the accounting-tallies approaches apply here as EPS, for instance, is a poor summary of the value created per share.
  
  
  
   
  
  
  
  • Vulnerability to business fluctuations. Is the current year’s EBIT or EPS “normal” in any sense? For most businesses, it is not, since most businesses experience some kind of operating
  
  
  
   
  
  
  
  • Vulnerability to changes in the firm’s life Perhaps the fundamentals of the firm’s business are changing. For example, a frequent mistake is to grant a firm a “high growth” multiple, when in fact the firm is entering a more mature phase of its life cycle.
  
  
  
   
  
  
  
  • Tendency to ignore differences in fundamentals across firms. Choosing comparable firms on which to base an estimate of the P/E ratio can be the source of considerable error. In pharmaceuticals, for instance, no two firms are alike, because each is a monoplist in a few key drugs or group of drugs; the rate of new innovation tends to shorten the life cycle of those monopolies; and government regulation, product failures (e.g., thalidomide), and the occasional cyanide scare affect drug companies unequally. Naive and unsophisticated choice of a P/E multiples based on other drug companies can ignore significant differences in competitive
  
  
  
   
  

  These weaknesses notwithstanding, the use of the multiples approach by a sophisticated and highly informed analyst can produce meaningful valuations. The critical determinant is the analyst’s careful understanding of the business being valued, of the fundamentals of comparable companies, and of accounting policies.

  
  

The discounted cash flow approach penetrates accounting cosmetics because it focuses on cash, not reported earnings. Furthermore, it explicitly accounts for cyclical and secular changes in the firms’s business.

DCF requires the analyst to make explicit assumptions about the fundamentals of the firm’s business, which is a disadvantage if the analyst would rather not go to all that trouble. It also forces the analyst to admit that valuation is a tenuous process--as much artful, intelligent thinking as scientific calculation. In a world that pays a premium for solid, certain numbers, a valuation based on many “iffy” assumptions would not seem to have much value at all.

But the explicit uncertainty of the DCF approach is its strength. No valuation approach gives a completely certain value. DCF recognizes that and allows the analyst to bound the range of possible values and to identify the key assumptions that drive the outcome. This is an important advantage, for instance, in giving a presentation that is open to questions or in preparing to negotiate a securities offering, a merger, or a divestiture. It helps prepare the presenter or negotiator to respond flexibly to any new information that may be revealed in the meetings.

The bottom line is that, unless the analyst is unusually familiar with the business being valued (e.g., an industry specialist in a securities firm or an industry-oriented lender in a bank), the discounted cash flow approach may provide a more accurate evaluation of the firm’s future performance than will the approaches based on multiples.

Reconciling the Discounting and Multiples Approaches  企业金融专业代写

A frequent response is, “OK, discounting is the way to go. But my customer doesn’t understand discounting. He only understands P/E ratios. What should I do?” The customer’s attitude indicates the greater sophistication needed to complete a DCF valuation and reflects the understandable distaste for the ambiguity inherent in valuation. The solution is to present the valuation in terms of P/E ratios but base the analysis on DCF. This appears to be the modus operandi at many investment banks.

To illustrate: the analyst would first value the firm under the DCF approach, possibly producing a range of values depending on different sets of assumptions. These values would be converted into share prices, into which would be divided the next period’s expected EPS. Then the range of resulting P/E ratios could be compared with those of other firms in the same business. Based on a careful consideration of business fundamentals, a P/E ratio out of this range would be chosen and presented to the customer.

Again, the ultimate outcome is that, even if the analyst finds it necessary to present results in another form, the DCF approach can still be used to advantage in laying the groundwork for the final recommendation.

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