VALUATION CONCEPTS AND METHODOLOGIES

❖ MARKET VALUE APPROACH

Market Value Approach follows the concept that the value of the business can be
determined by reference to reasonably comparable guideline companies for which transaction
values are known. The values may be known because these companies are publicly traded or
because they were recently sold, and the terms of the transaction were disclosed. The business
valuation methods under the market approach that are typically used in professional business
appraisals include comparative transaction method/comparative private company sale data
method, guideline publicly traded company method and use of expert opinions of professional
practitioners.

Market-based business valuation methods are routinely used by business owners, buyers
and their professional advisors to determine the business worth. This is especially so when a
business sale transaction is planned. After all, if you plan to buy or sell your business, it is a good
idea to check what the market thinks about the selling price of similar businesses.

The market approach offers the view of business market value that is both easy to grasp
and straightforward to apply. The idea is to compare your business to similar businesses that
have actually sold.

If the comparison is relevant, analysts can gain valuable insights about the kind of price
the business would fetch in the marketplace. Analysts can use the market-based business
valuation methods to get a quick sanity check of the pricing estimate or use this as a compelling
market evidence of the likely business selling price.

All business valuation methods under the market approach fall within one or more of the
following categories. It is either based on statistics/empirical or heuristics or combination of
these methods.

❖ Empirical / Statistical Approach

Empirical or Statistical approach generally uses research and database processing in order
to come up with conclusion and recommendation. The approach requires references and
evidences to support the determination and evaluation. Information may take the form of Sales
Data, Financial Performance and other historical information. Trend analysis and benchmarking
maybe used to process the information. Tools are also made available to facilitate processing
large information.
❖ Comparative Private Company Sales Data

This is an empirical approach. This is formerly known as comparative transaction method.

Other literature called this as guideline transaction method or comparative business sales data.

This method involves finding out prior transactions (i.e. mergers and acquisitions,
divestiture, etc.) of comparable companies. Such a transaction might represent either a minority
perspective or a majority perspective. Transactions data can be obtained by finding out the exact
industry of the business under consideration using the established industry classification methods
and searching valuation databases for historical valuation evidence. A number of publications
collect and disseminate information on transactions. Most publications make their databases
accessible on the Internet for free on a per-use basis or annual subscription access. Among the
most widely used are:
● Institute of Business Appraisers (IBA) BIZCOMPS®

● Pratt's Stats TM

● Done Deal™M

● Mid Market Comps™ (ValueSource)

● MergerstatⓇ

An ideal guideline transaction would be the one from a very similar company in the same
industry. If no direct comparison is available, other data might be used after considering their
market, products, etc. Transactions data required adjustment for the transaction-specific factors
such as non-compete agreement, employment contracts, etc.
In selecting which method to employ in a valuation assignment, the definition of value,
the size of the company being valued and the magnitude of the valuation stake (majority vs
minority) are important. A majority stake in a large well-established should be valued relative to
either (a) a prior transaction of the same company involving a majority stake or (b) guideline
transactions representing a majority stake involving a comparable company. A minority stake
should be valued using the guideline public company method after applying proper discounts and
adjustments.

The advantage of this approach is that source data is reliable and comparable data
includes sales of small businesses that can be similar the small business being valued. Although
the limitation of this approach is that there is insufficient market evidence in some industries, and
it will require careful data selection, analysis and consistent data reporting standards.

❖ Guideline Public Company Data

The guideline public company method involves identifying a comparable company and obtaining
the stock price for the company's listed securities. Publicly listed companies (PLCs) are required
to file their financial statement electronically with the Securities and Exchange Commission
(SEC). These filing are public information and are available on the SEC website at
https://www.sec.gov.ph. Information are also available in Philippine Stock Exchange website at
https://pse.com.ph

In most cases, the stock prices as obtained from a public market represent a minority
stake. The advantage of this method lies in the availability of a large set of recent data. However,
it might not be very appropriate in valuing early-stage and/or small businesses. In using public
company data to value private companies, proper adjustments must be made to the benchmarks
being used on account of size, growth potential, capital structure, business life cycle (i.e. early
stage or maturity), etc.

The advantage of this approach is that there are plenty of transaction data available from
the public capital markets. Business sale data reporting is generally consistent and reliable and
business financial reporting data are readily available. Although it can be noted that the
limitation of this approach is that comparison to small businesses may not be as relevant, the data
generally involves sales of non-controlling business ownership interest (not the entire company)
and data requires adjustment for lack of marketability of private company ownership interest.

❖ Prior Transactions Method

The prior transaction method involves looking up historical transactions in securities of

the business undervaluation. The valuation might be for minority stake such a historical stock
quote from a listed stock exchange or it might be for a majority stake such a merger and
acquisition transaction involving the business. Additional considerations in selecting prior
transactions as a benchmark include the timeline of the transaction, the economic situation at the
time of the transaction, etc.

The advantage of this approach is that it is already a good reference for valuation, if the
data is available. Since this is reliant heavily on the data, absence of a good data may not enable
this approach to produce reliable results.

❖ Comparable Company Analysis

In Financial Management, financial ratios are used as tools to assess and analyze business
results. Recall that one of these purposes can be used to determine the value. These financial
ratios are P/E Ratio, Book to Market Ratio, Dividend Yield Per Share and EBITDA Multiple.
Ratios or multiples are useful tools for doing comparative company analysis. The advantage of
having ratios and multiples is that it creates better and relevant comparison knowing that
opportunities or investments have distinct drivers of their performance.

Comparable company analysis is a technique that uses relevant drivers for growth and
performance that can be used as proxy to set a reasonable estimate for the value of an asset or
investment prospective.

In determining the value using comparable company analysis, the following factors must be
considered:
 ● Comparators must be at least with the similar operations or in the similar industry

● Total or absolute values should not be compared

● Variables used in determining the ratios must be the same

● Period of observation must be comparable

● Non quantitative factors must also be considered

Price - Earnings Ratio

Price - earnings ratio (P/E) Ratio represents the relationship of the market value per share and the
earnings per share. It sends the signal on how much the market perceives the value of the
company as compared to what it actually earns. P/E Ratio is computed using the formula:
Market Value Per Share
Earnings Per Share

P/E Ratio =

To illustrate, Chandelier Co. is a listed company with the market value per share of Php12.0 and
reported earnings per share of Php4.0.

Using the equation, the P/E ratio is 3. This means that the Chandelier Company can
create 3x the value of what it earns. P/E Ratio is also known as P/E Multiples or Price Multiples.
To determine the value of a company using P/E ratio, management accountants and analysts use
P/E of the comparable company.

For instance, Jopet Hotels and Leisure is a hospitality company. Based on the income
statement of the company, it reported earnings of Php7.00 per share. Based on the listed
companies under hospitality industry, the average P/E ratio is 4.25. With the foregoing
information, you can expect that the value of Jopet Hotels and Leisure is Php29.75 per share
[Php29.75= Php7.00 x 4.25].

❖ Book-to-Market Ratio

Book-to-Market ratio is used to determine the appreciation of the market to the value of the
company as compared to the value it reported under its Statement of Financial Position. It may
be recalled that the book values of the company are based on historical costs and does not purely
incorporate the value in the market now. However, the only limitation of this ratio is that certain
values incorporated do not represent the true value of the company. Hence, further due diligence
is imperative.

Book-to-Market ratio is computed using this equation:

Net Book Value Per Share
Market Value Per Share

Book to Market Ratio =

Book Value per share can be derived by dividing the net book value to the number of
outstanding shares available to common or ordinary. Net book value is the difference of the total
assets and the total liabilities. This represents the claim of the equity stockholders to the
company.

To illustrate, Chandelier Co. reported a Book Value per share of Php35 and with a market value
per share of Php12.50. The Book-to- Market ratio is 2.80 which is computed as follows:
35.0
12.50

Book to Market Ratio =

 Book to Market Ratio = 2,80

This means that for every Php35 per share that is owned by a stockholder it is 2.8x larger than its
value in the market.

If Book-to-Market approach is used for comparable company analysis, the key component of the
financial statement needed is the Statement of Financial Position. To illustrated, Jopet Hotels and
Leisure reported a book value per share of Php 16.5 and the hospitality industry average Book-
to-Market is 0.5, then the value of Jopet Hotels and Leisure can be estimated around Php33 per
share [Php33 = Php16.50/0.5].

❖ Dividend-Yield Ratio

Dividend Yield Ratio describes the relationship between the dividends received per share and the
appreciation of the market on the price of the company. Dividend-Yield Ratio is also known as
dividend multiple. Next to Price Earnings Multiple, this is also a popular tool because it provides
the investors with the value which they can actually get from the company.

The Dividend Yield Ratio (DYR) is computed using this equation

Dividend Per Share
Market Value Per Share

Dividend Yield Ratio =

To illustrate, Chandelier Co. declared and paid dividends of Php1.50 per share and their market
value per share is Php12.50. Based on the foregoing, the dividend yield ratio is 0.12 computed as
follows:
Dividend Per Share
Market Value Per Share
 DYR =

DYR = Php150
Php12.50
DYR = 0.12

This means that for every Php1.50 dividends they pay it will translate into 12% of the market
value of the equity. Using this as a tool for comparable company analysis, DYR will works as a
multiplier to the dividends per share declared by the company.

Suppose that Jopet Hotels and Leisure declared Php1.5 per share and the average dividend
multiple of the similar industry is 0.047. The market value per share can be estimated to be
around Php31.91 per share [Php31.91 = Php1.50/0.047]

❖ EBITDA Multiple

EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization represents for the
net amount of revenue after deducting operating expenses and before deducting financial fixed
costs, taxes and non-cash expenses. Given the components, EBITDA can serve as a proxy of
cash flows from operating activities before tax. Traditionally, cash flows from operating
activities is computed by collections less payments for operating expenses. Indirectly, EBITDA
can be computed from net income plus depreciation and amortization and incorporating working
capital adjustments.

⮚ EBITDA Multiple is determined by this equation

EBITDA Multiple = Market Value per Share

 EBITDA per share

EBITDA per share is derived by dividing EBITDA by outstanding share for common equity or
ordinary shares. To illustrate, Chandelier Co. reported EBITDA per share of Php6 and the
market value per share being Php12.0. Given the equation the EBITDA Multiple is 2 [2 =
Php12.0+ Php6.0]

This means that the value of the firm to the market is 2x for every peso of EBITDA earned. In
practice, others adjusted the EBITDA to incorporate costs relative to other quantified risks. This
is done by adding more costs or recognizing contingent expenses to generate a more conservative
EBITDA results which will serve as driver for the value of the market.
To illustrate, Jopet Hotels and Leisure reported an EBITDA multiple of Php8.50 per share. The
average EBITDA multiple of the hospitality industry is 3.5. Given the foregoing, the value of the
equity is about Php29.75 [Php29.75 = Php8.50 x 3]

To illustrate further, it also assumed that will have to procure insurance and security costs
to protect the plant assets of the company. This is about Php0.5 per share. Given this
additional information on the foregoing, the value of equity is Php28.0 [Php28.0 =
(Php8.50-0.50) x 3.5]. You may note that the value of the firm decreased by Php1.75
[Php1.75 = Php29.75 - Php28.0] after the risk management cost is incorporated.
In summary, comparable company analysis uses tools to enable the Strategy, comparison
between companies given the differences in 3s
Structure and Size. The objective is to enable the analyst or management accountant to determine
the value of the company based on the behavior of similar businesses in the industry that more or
less captured the risks factors and other micro and macro-economic considerations.
In the given illustration we can compare the results generated using comparable company
analysis under various tools
discussed:
We can say that after using various comparative tools the price of Jopet Hotels and Leisure is
between Php29.75 to Php33.00, subject to due diligence.

Heuristic pricing rules method

Another method may consult and use the expert opinion of professional practitioners which uses
Heuristic pricing rules method. In this method, analysts use business pricing formulas that are
developed based on the expert opinion of professionals involved in business sales. The best-
known professional group that does this is the business intermediaries that broker business sale
transactions in specific industries. Their knowledge of the marketplace and direct exposure to
transactions puts these experts in an excellent position to estimate the likely business selling
price.
The advantage of this approach is that pricing multiples based on the expert opinion of active
market participants is made available. Also, pricing formulas are often relied upon both by
practitioners and their client business owners and buyers when pricing a deal.
However, since these are based on expert's opinion, pricing multiples may not be sufficiently
backed by rigorous statistical analysis. There will also be a concern on availability of
information for non-brokered business deals.

SUMMARY
Empirical/ Statistical approaches has 3 methods which are dependent on the sources of
comparable data: Comparative private company sale data, Guideline public company data and
Prior transactions method
Comparable company analysis is used to determine that value by comparing an asset to the
performance of the similar company or at least the industry where that asset belong.
To calculate value or price of a company, in simple terms, uses pricing multiple derived from a
particular financial ratio of the company or average of similar companies where the subject
company is being compared.
The comparable company analysis applies P/E Ratio, Book to Market Ratio, Dividend Multiple
and EBITDA Multiple.
P/E Ratio defines the relationship between the market value per share and earning per share
Book to Market defines the relationship between the book value per share and the market value
per share.
Dividend Multiple or Divided Yield Ratio provides for the relationship between dividends per
share and market value per share
EBITDA Multiple establishes a multiplier to determine the equity price based on EBITDA or
Earnings before interest taxes depreciation and amortization.
Heuristics uses Heuristic pricing model which uses expert opinions of professional practitioners.

REFERENCES
Book/s:
Valuation Concepts and Methodologies by Marvin V. Lascano, CPA, CFC, DBA et al.

E-sources:
https://www.youtube.com/watch?v=v8w5m3X8sCM

https://www.youtube.com/watch?v=tNxvpZCecvk