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3 ways to value a company - MoneyWeek Investment Tutorials



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welcome to this week's money week video

and this week I want to deal with a

topic that's a few people have asked

about it's a pretty big meaty topic it

is how do you value a company now

obviously that's something that

Predators want to do before they take

over a target to use take over language

and it's something that investors should

have an interesting when you're buying a

share you want to be looking at you know

am I getting good value for money or not

and how do I think about the value of

the company well to cut to the chase how

do you think about the value of any

asset take a house for example arguably

there are three ways you can decide

whether or not to buy a property you

could do a sort of bottom-up estimation

of what it would cost by the land and

build the thing that will give you a

number okay you could look at the price

of houses nearby they won't be identical

but that will give you some feel for the

one you're looking at or you could say

actually maybe a property is only worth

what someone's prepared to pay to live

in it so you could sort of do a

calculation of all the future rent that

the asset might generate and then bring

it back into today's money terms using a

technique I've covered in another video

called discounting all right

Caesar called bottom-up

bricks-and-mortar approach the house

next door approach and the value from a

rental perspective approach now those

won't all necessarily give you the same

number they'll give you a range okay and

then it's the buyer you negotiate the

lowest price possible as a seller you'll

to negotiate the highest price possible

well what's that got to do with today's

topic companies can be valued using a

sort of similar three-pronged approach

if you like so in this video all I'm

going to do is outline those three

approaches and then maybe in future

videos if there's demand out there I can

take that on a stage further so how do

you do it right well fundamentally it's

an art rather than a science

all right there are numbers involved at

the end of the day a company like a

house is only worth what someone's

prepared favorite and now I want as

little as possible call the seller you

want to get

much as possible so the idea is to

establish a range against a range to get

the negotiation going in and then

obviously sellers look to achieve the

top end of the range and buyers look to

achieve the bottom end of the range and

how does it work well three approaches

remember what I said about the house

just now

all right well I was a little bit loose

and fast with the facts

but those three approaches I described

also describe the way that you can go

about valuing an entire company okay one

of them is what's called the asset based

approach now in this video I'm just

going to introduce the language I'm not

going to go into this any detail but

essentially you could take a company's

balance sheet as a starting point you're

not sure on earth the balance sheet is

see my video it's a popular one what is

a balance sheet okay you could start

with a company's balance sheet look at

the list of assets make some adjustments

according to as a buyer whether you

think they're fairly safe store not and

come up with a kind of asset based

valuation but do you just stop there no

okay

because chances are you're not buying

the company to simply wind it up and

flog off the assets chances are you're

buying it

okay so predator for example RS and

invest you're looking at the longer term

so we're looking at what you can squeeze

out of it so another approach would be

the house next door approach okay this

is going to break some water approach

the house next door is called or well

I'll call it ratio based and if there's

demand we can cover the East other

videos okay we may come across this one

if you've done a bit of this stuff

before ratio base is essentially saying

well let's take similar companies so

ones from the sector that this company

operates in let's look at something like

their p/e ratio or their price to sales

ratio again topics I cover in other

videos what is a p/e ratio it was the

price to sales ratio okay and let's see

if we can come up with a sort of

comparative number for the company

we're looking at alright um now very

very simply very very simply this works

on this sort of premise you know the P

ratio is the relationship for example

putting the current share price of a

company and one year's earnings all

right so you know if you've got sort of

let's say a p/e ratio of ten okay you

can rearrange this formula if you like a

bit of maths and say well the value of a

firm is equal to just multiplying that

out ten times earnings all right if

you're into maths you can do a bit of

rearrangement okay so P is equal to 10

times earnings so what you can start to

then do is say well you know if I can

come up with the right earnings figure

and if I think that 10 is about the

right multiple to apply to the firm I'm

looking at based on other similar

companies I can start to come up with a

value for P that was a little bit quick

and dirty but you saw may get the basic

idea from there okay and the third and

biggest and Junkies method okay is

what's called discounted cash flow DCF

that's the kind of what's our property

worth looking at it's rental income in

the future time approached okay I'm not

going to cover that in this video could

do an entire video on that quite

comfortably that's the idea that what

you actually want to do is to forecast

the earnings and cash flows that the

company will generate looking into the

future and then bring them back to

today's money using what's called a

discount rate okay and I do cover that

in another video in outline terms okay

so there we have it want to introduce

their ideas all I've done here that

there are several ways you can value a

company and there's a predator obviously

is vital okay so you don't overpay for

it as an investor is quite important too

okay

so those three methods are asset based

bottom up take a balance sheet

see what the company is worth a balance

sheet point of view make some

adjustments based on what you think

assets and liabilities might really be

worth the ratio based approach that says

let's look at similar companies get a

handle on a typical multiple for the

sector and then take a number for the

company we're looking at and multiply to

get the price that can be done using the

p/e ratio the price to sales ratio it

depends on the company depend on sector

and the third approach which is a biggie

discounted cash flow okay that's used in

many many many situations okay it's

unusual to just do one of these quite

often you're funded two or three of them

DCF the hardest involves the most amount

of work projecting cash flows into the

future discounting them back to get a

price or a value today all right and

then armed with those different numbers

because these could easily throw out

three different numbers hopefully not

totally divergent you then begin if

you're buying a company the negotiation

on what you're actually going to pay

based on the range of these three

techniques are just generated hope

that's been useful see you in the next

video

you