By Robert Bradford, President/CEO
In my earlier posting about evaluating acquisition targets, I discussed four common approaches to evaluation a company: market value, asset value, operating value and strategic value. Today we will look at the exact approaches to market value and asset value, with objective formulae.
First, market value. The objective numbers for this come, obviously, from a market – usually, the stock market. There are two approaches here: direct value and proxy value. The formula for direct value is only applicable for public companies:
Value = Stock price X Number of shares outstanding
If there are very similar public companies on the stock market, you can use proxy value:
Value = Target company earnings X EPS of similar public company
Be aware that this second approach involves some shaky assumptions about the similarity of the two companies, and in some industries, assets, sales or some other number may be more useful in calculating a proxy value. Due diligence when using this as a value basis should be about understanding the similarities and differences between the companies, as well as the normal look into the fundamental soundness of the business.
The second approach is asset value. Again, there are two common approaches, each with limitations. The easiest (and least accurate) is accounting asset value:
Value = Book value of net assets on balance sheet
The limitation of this valuation is that, as with any balance sheet item, assets may be over or undervalued. The true value of a piece of real estate is rarely represented well on a balance sheet, for example.
A more difficult approach to asset value is market asset value:
Value = (Sum of market value of assets) – (Sum of market value of liabilities)
This requires an added step over the plain accounting value – you have to research and quantify the market value of the important assets of the company (usually, real estate and similar holdings). There are times when this valuation is a very important part of what other buyers are willing to pay for an acquisition target, so you should be aware of it.
In postings to come, I will discuss the formulae for operating value and strategic value.