How to do Valuation of any Company
Stock valuation is the process of estimating a company’s stock price. This determination is reached by considering a number of factors that help to determine whether the firm is overvalued, undervalued, or at par. Let’s look at how to value a company so we can determine whether or not it’s a good investment.
Company Valuation Approaches
The following are some of the most common approaches used to determine a company’s worth:
Income Approach
The DCF technique is another name for the income approach to valuation. As a result of a discounting of expected future cash flows, an estimate of the company’s true worth may be made. In order to calculate a discount rate for future cash flows, the cost of the company’s capital asset is used.
The value of the shares may be calculated by discounting the expected cash flows into the present. This aids in determining if the firm’s valuation is overvalued or under-valued or at par. This is a common technique in the field of finance.
Asset Approach
One of the simplest approaches to a company’s value is to look at its Net Asset Value (NAV). The “Fair Value” of each asset must be determined for the NAV calculation to be complete, as this value may differ from the asset’s original purchase price or its most recent recorded value.
Fair Value must be established before NAV can be estimated; however, once established, NAV is simply calculated as:
NAV
Net Asset Value or NAV= Fair Value of all the Assets of the Company – Sum of all the outstanding Liabilities of the Company
Company NAV calculations get more difficult when intrinsic expenses like Replacement Cost must be included in. In addition, the replacement cost of an indispensible individual who is crucial to the organisation is a factor in determining the Fair Value of the company’s “Assets.”
For this reason, companies with a large number of easily measurable tangible assets are valued using the asset-based method rather than the intangible one. The goal is to determine the stock’s worth by comparing the current market price to the cost to replace the asset.
Market Approach
It’s the most popular way to assess a company’s worth and is sometimes referred to as the relative valuation approach. Using key parameters like as the price-to-earnings ratio (P/E), the price-to-book ratio (P/B), the price-to-earnings growth rate (PEG), the enterprise value (EV), etc., we can compare the value of the firm to that of similar assets. Due to inherent variability in company size, ratios provide a more accurate picture of efficiency. In addition to analysing financial statements, similar calculations are also performed.
Different measures are used to determine various aspects of a stock’s value.
- P/E Ratio (Price to Earnings Ratio)
The Price Earnings Ratio, or PE Ratio, is calculated as follows. The ratio is calculated by dividing the stock price by the earnings per share. In reality, this is one of the most often employed methods for determining whether a stock is fairly valued.
- Price-to-earnings ratio (PE ratio)
One way to approximate the worth of stock is to multiply it by the Profit After Tax. Many people get this wrong, despite the fact that it is the most common ratio.
One big problem arises when a PE ratio is used. Due to the fact that “Profit After Tax” can be skewed by a variety of accounting techniques and instruments. However, a history of the profit after tax is necessary to achieve a more precise PE Ratio.
Price to Sales Ratio (PS Ratio)
Market capitalization (i.e., share price multiplied by the number of outstanding shares) is multiplied by yearly sales to arrive at the PS Ratio. It may also be worked out on a per-share basis by dividing the Share Price by the Company’s Net Annual Sales.
- PS Ratio= Stock Price / Net Annual Sales of the Company per share.
Compared to the PE Ratio, the Price/Sales Ratio is a far less skewed indicator of value. That’s because market share can’t be skewed by inconsistencies in financing. When earnings are inconsistent, the P/S ratio can be very helpful
- Price to Book Value Ratio (PBV Ratio)
This is an older and more common approach to appraisal. If the stock’s price is high relative to its book value, the ratio is said to be high. This is the preferred approach of value investors and many market experts.
- PBV Ratio= Stock Price / Book Value of the stock
When the PBV Ratio is 2, investors are paying twice the book value for each share of stock ($2).
However, this ratio has one major flaw: it does not take into account the company’s future earnings or intangible assets. Because the revenue from this strategy is so closely tied to the value of assets, it is favoured by businesses like banking.
- EBIDTA (Earnings Before Interest, Tax and Amortisation)
We find this ratio to be the most accurate. In this case, profits are included in before interest, tax, or loan amortisation is applied. In addition, it is not skewed by things like the capital structure, tax rates, or non-operating revenue.
EBITDA to Sales ratio= EBITDA / Net Sales of the company.
EBITDA will always be < 1 as interest, tax, depreciation and amortisation would be considered from the earnings.
We hope this article help you in Valuation of your company