How to value a company using net assets - MoneyWeek Investment Tutorials

[Music] [Applause] [Music] so welcome back to my video series on valuing companies those of you who've seen my introductory video three waves to value a company have been asking me can I go a little bit further and take on one or two of the techniques dye illustrate very briefly in that video so in response to those queries here is my tour of one of the three techniques I introduced in that initial video now a quick recap for those people who haven't seen the video and are scrambling around wondering where it is it's called three ways to value a company it's very basic and in it I describe basically two approaches to value a company and the second one splits in two to give you the third method so in that video I talked about a bottom-up approach this is the objective here my way is if you're a predator about to buy a company you want to know what it's worth how much should you pay obviously want to pay as little as possible we could have justify the price in some way sellers have to justify their price as an investor these can be useful reference techniques for looking at you know am i buying a share at the right price level and bottom up is what I'm gonna cover today now bottom up is basically what it sounds like there is a way of saying well one way to approach valuing company would presumably be to get hold of its balance sheet that's the statement of net worth if you like start there and maybe make a few tweaks to get to what I think the companies are really worth on the open market that's what I'll be covering just a moment because as a reminder not the only way to go about it okay there are what I could loosely call top-down approaches to valuing companies all right that can be split roughly speaking into two types of techniques there's using multiples and there's DCF now traveling rather fast because I may well take on these in other videos but essentially you can use things like p/e ratios and price to sales ratios to sort of extrapolate a value for a company looking at all right and you can use a thing called discounted cash flow which is quite a meaty topic which I'll tell you may take on another video of Farrah quest for that and that is projecting future cashflows bringing them back to today's money using a discount rate right fairly hairy stuff but what we're gonna do today is take the almost the simplest of those three one two three I'm going to call this the assets approach so that's two your three techniques assets multiples and DCF all right gonna focus over here and just ask the question how would I go about that all right well I gave you a hint just now and this is gonna be a rough guide I could say a lot more but just gives you a flavor of how this works okay now why would you start you'd pick up a set of accounts and you'd say what is the statement of net worth as far as the accountants are concerned all Lord it isn't signed off it's called a balance sheet alright now for those people who are thinking one hearth is a balance sheet I would urge you strongly to look at my video not surprisingly entitled what is a balance sheet and that's a really good starting point what I'm about to say because in that balance sheet you'll find an estimate using accounting rules of what the company is worth so I'll call that net assets and that might be let's say a hundred million not very big company that says a hundred million in sterling now you might say well there we go that's what the company's worth I mean the balance sheet says 100 million now assets that's signed off by auditors and so on it's official documentation so that we are the company is worth 100 million and if it had 100 million shares an issue you could say each one's worth pound hundred million over a hundred million life isn't quite that simple why because balance sheets are a good starting point that after all they're verified you know by a set of auditors and blah blah blah blah but there are problems with them they don't represent what you would actually pay to buy the company in the open market okay why not well first of all you need an up-to-date the asset statement and if you just pick up a set of accounts published the last time the company did its full set of accounts you're probably several months out of date already even leaving that problem to one side supposing you could get a balance sheet looks right up to the minute you still wouldn't rely on it 100 percent as the basis of saying well what their company's worth I can look at the share price and and judge whether I'm overpaying or under paying or as a predator I can judge whether I want to pay that price a bit more a bit less and so on okay so why well the answer is basically the balance sheets are sort of incomplete and they're prepared using accountants rules and that gives them one or two failings when it comes to really valuing the company in today's market terms what are those alright well you could have assets that are either missing from the balance sheet or assets that are in the balance sheet as part of this net asset 100 million but are overstated okay so you end up with asset adjustments and they could be positive or negative but what I mean by that well it may be that the company has written off certain assets completely following the accounting rules that you think have some value as a predator okay you think that you have some value so you'd have to tweak up the figure in the balance sheet take account of that all right now someone buying company you want to pay as little as possible but unless in the back of your mind you're thinking well those are worth something and why don't they appear in the books okay could be old patents licenses that kind of thing alright then equally you might want to knock some off you might say I'm knocking five million or 400 million asset figure because I think the stock figure in the balance sheet is overstated there's no way it's gonna be worth that much to me as a buyer or I think the receivables figure is optimistic okay so there are little adjustments there as a predator you might start to make to get to a truer figure of what you think the company's worth by the way you might enlist the help of accountants doing doing what's called due diligence in sort of corporate finance department to help you with this exercise if it starts to sound a bit technical okay so you're gonna go through the assets making adjustments another example where you may need to make a positive or negative adjustment is accountants often leave assets in the balance sheet at what's called historic cost validate land in buildings for example you might want to get some surveyors in keeping up-to-date valuation and change their house Africa accordingly okay on the other side the reliability adjustments just giving you a real flavor for this okay positive or negative so what I'm saying is you'll end up with the revised number based on making those adjustments it could be more than hundred million or less nine billion liability adjustments could be what well imagine you're buying a tobacco firm for example okay what sort of liabilities that may not have been fully captured on the balance sheet might you have to adjust for legal things okay the Countians have a habit of saying well you can't record a legal claim against those and assets unless it's reasonably certain the impacts reasonably well-known okay but it's a buyer you'll be thinking whoa crikey oh yeah if I'm buying this thing and I load a legal claim suddenly hit me I've got to cover them there'll be my problem then okay so you might make you know downward adjustment by pumping in some more liabilities okay there could be hidden nasties that are not reflected in that number that you're worried about as a buyer or even as an investor okay because these so-called contingent liabilities to use the accountants language or a matter of son judgment judgment all right so the point is this superficially the assets approach to valuing companies is quite straightforward in the sense that you take a reasonably reliable starting figure tweak it up or down okay according to what you think assets are worth or what you think the true liabilities position is and arrive at a revised number you know as a predator you'll want that to be as low as possible as the person selling this business choice when it's been high as possible then you get into a little bit of algae bar gene negotiation all right but it's not as straightforward as I've made it sound because you know some of these adjustments you need to have your wits about you and that's where in practice people who do buy and sell companies tend to bring experts in to help them in the form of you know you've chartered accountants working for corporate finance departments investment banks and so on okay well that just gives you a flavor and you don't even stop there all right valuing companies is tough it's not easy there's no quick method you get a number say one hundred and twenty million and then you might think well is this the right approach the business on buying or looking at as an investor what sorts of businesses would you apply and based approach to or there's a clue in the name businesses with a lot of assets what are those well you could be looking at so property investment companies for example investment trusts companies this sort of approach works better for those than it would for an internet or software firm where frankly there isn't much in the way of net assets to start with okay so now this approach is one approach depending on the type of companies almost certainly go on and look at multiples and look at DCF to give you the biggest range of possible valuations to the company open your negotiations or as an investor to give you some reassurance that the company is worth what other people seem to think it's worth okay so they have it a fairly quick guide to one out of three ways of potentially arriving at the correct inverted commas value for a firm I hope you enjoyed that video and in future videos I'll take on a couple of these other areas for those people have asked about you

Channel: MoneyWeek

Views: 196,630

Keywords: deals, ratios, losses, inflation, bank, payments, claims, successful, Dividend, stocks, shares, Overtrading, profit, loss, Bid, offer, spreads, Currency, credit, Trading, Trade, Tax, trade, economy, whiteboard, tim bennett, Banking, profits, Accounting, Asset, Purchase, Reverse, QE, Company valuation, Net assets approach, DCF, Predator, Target, How to value shares, Valuation techniques

Id: rV68zoBKTJE

Length: 10min 12sec (612 seconds)

Published: Fri Jun 21 2013