The financial markets have recently witnessed Facebook Inc. going public. This is one of the largest IPOs the world has seen. In hindsight, it could be argued that this IPO was overpriced because during the first six months of being public, the share prices fell by more than 50%. Would you have been able to make your own judgment about the fairness of the issue price? Was this price within what could be called a reasonable price range? To thoughtfully answer these questions, you have to apply valuation methods. Regardless of whether you are part of the management team of a company going public or an investor looking for an investment opinion, you should to be able to use discounted cash flow and relative valuation methods.
Moreover, valuation is used in many other circumstances, including mergers and acquisitions and stock picking. Whether the firm is looking for takeover or merger opportunities or whether it becomes a takeover target, a good understanding of valuation issues is a prerequisite to handle these situations successfully.
Before you arrive at a valuation for your firm or asset, you should be able to understand several factors:
- Relative valuation as opposed to discounted cash flow (DCF) valuation.
- Pros and cons of relative valuation.
- The different concepts of firm value and equity value multiples.
- Important multiples such as FV-to-EBITDA, FV-to-EBIT, price-to-book ratio, and price-to-earnings ratio.
- How to implement these valuation methods in practice; most importantly, how to gather data.
- Pitfalls that should be avoided when using these methods; such pitfalls are related to the problem of determining the correct peer group, taking into account the effects coming from different accounting standards.
Do you and your colleagues know the difference between the discounted cash flow method and the relative valuation method? If so, are you aware of the various multiples that can be used for valuing your firm? Are you familiar with all the practical aspects of these multiples? The Accenture Academy course Using Financial Ratios for Valuation discusses relative valuation, multiples, and practical aspects of multiples and will enable you to do a simple multiple valuation for an asset.