How do I value a company?

Question

I have just started work as a junior resource (equity) analyst and my new boss has asked me to value a company we are looking at. Its a bit of a drop in the deep end so how would I go about doing this???

My understanding from CFA Lvl1 of valuations is that youd start with DCF or perhaps P/E? any guidance would be great...

Thanks

Answer 1

man i could write a book.   there are three methods for valuing a company: the income approach, market approach and cost approach.  let's ignore the cost approach -it's just ajdusted book value.

the income approach consists of teh DCF, dividend discount models (which are essentially the same thing), and capitalizing free cash flow.  it sounds like you know the basics re the DCF.  There are various measures for cash flow.  For valuation, you are using either debt-free cash flow or free cash flow to equity.  If you're discount rate is the WACC, use debtfree CF.  If it's just the cost of equity, use FCFE.

DFCF = EBIT (1 - tax rate) + Depr/Amort. - CAPX - Net Working capital provisions.

FCFE = Net Income + D/A - CAPX - Gross Working Capital +/- Debt Repayments.

If you're capitalizaing cash flow, you want to make normalizing adjustments by adding back nonrecurring expenses, and subtracting out nonrecurring gains.

the market approach is applying multiples of earnings/bv/sales/EBITDA  or even other metrics like Dollars per Million Customers or whatever to the subject company's fundamentals.

So if you're valuing a car mfgr - say Ford, Chrysler and GM are trading at an average of 8 times EBITDA.  You would maybe make some qualitative adjustments to account for growth, risk and profitability and multiply 8 (ajdusted up or down) by your company's EBITDA.  This gives you enterprise value, so subtract out debt.   If you take a multiple of net earnings, don't subtact debt.  

multiples of EBITDA are usually Invested Capital to EBITDA.  whereas multiples of net income are usually MV of Equity to NI.

you can also use transactional multiples from actual sales of cmopanies as comparables.  you can also use rules of thumbs.  for example, pipeline companies at one time traded for 6 - 8 times EBITDA.  that was the rule w/in the industry.

Answer 2

You need to find the intrinsic value of the company.  Look at the balance sheet and do the simple math first.  Take your assets and subtract your liabilities.  Check it out against the sharecount.

Look at the past few quarterly reports.  What went right?  What went wrong?  Were there any one time gains or losses?

The p/e can be useful, but the e (earnings) can always change.  Look at the financials recently.  Cash Flows are important, but they are not always reliable.  Energy companies have massive cash flows and people, although they can cut back on their product, need their product.  Some retailers, on the other hand, sell goods that we don't necessarily need and can be negatively impacted by economic trends.

Another place to go would be to get some of the other reports that have already been written on the company that your covering.  Your outfit should have access to these reports. (If not check your brokerage)  Companies like Zack's and S&P cover tons of companies.

Definitely don't go word for word, but it will give you a good picture of where that the company sits.  

Good Luck to you!

Answer 3

Your company should have a financial model to perform this as this is their main business.

nevertheless, if its a new industry, ask your friends who works as an investment banker or for PE firm to provide you (if they could) with a model.

DCF is usual but would suggest APV as a better tool because it allow flexibility on your valuation esp because you would need to do stress testing.