The fundamental approach as the main tool for assessing the value of a company. Methodological approaches to enterprise valuation Fundamental value in business valuation is

The main criterion for choosing an adequate standard of business value is the source of income. In total, there are two sources of income generation when using the enterprise:

Income from the activities of the enterprise.

Income from the sale of enterprise assets.

Accordingly, there are two types of cost:

Cost of an operating enterprise. This value, reflecting the first source of income, assumes that the enterprise continues to operate and make a profit.

Enterprise value by assets. This value, reflecting the second source of income, assumes that the enterprise will be dissolved or liquidated, i.e. the enterprise is assessed element by element.

The most commonly used types (standards) of value, reflecting the sources of income:

1. reasonable market value of the enterprise;
2. investment value of the enterprise;
3. internal (fundamental) value of the enterprise;
4. liquidation value of the enterprise.

Reasonable market value- this is the most likely price at which property would pass from the hands of the seller to the hands of the buyer, when both parties are interested in the transaction, are not under duress, have sufficient information about the terms of the transaction and consider them fair.

In determining a reasonable market value, the market should be understood as all potential sellers and buyers of similar types of enterprises, the seller and buyer are persons acting with the typical motivation of participants in a competitive market (no specific buyer is meant).

The actual transaction price may differ from the reasonable market value due to factors such as the motivation of the parties, negotiation skills, and the terms of financing the transaction.

This definition implies that payment is made in cash. Other payment terms may affect the transaction price.

Thus, fair market value (sometimes called fair value or value in exchange) is the most likely price a particular business would pay in a free, open, and competitive market. This is an ideal standard that cannot always be calculated. If these assumptions are violated in an actual transaction, the term “market value” is used instead of the term “reasonable market value”.

The “reasonable value” standard is used to assess the reasonable market value of shares of a non-controlling (minority) stake. In the United States, fair value is a statutory standard of value used in cases to protect the interests of minority shareholders with non-controlling interests. The difference between fair value and fair market value is the consideration of the non-controlling interest discount.

Investment cost- this is the specific value of an enterprise for a specific investor (or group of investors), based on his personal investment goals. This is cost in use or subjective cost.

The investment value differs from the justified market value of the enterprise by differences in the forecast estimates of the future profitability of the enterprise by specific investors, their risk assessment, tax conditions (if the investor has tax benefits), the possibility of obtaining a synergistic effect (for example, the acquired business is built into the technological chain of obtaining the expected results) etc.

Intrinsic or fundamental value- this is the real value of the enterprise, determined by the analyst based on an analysis of the existing financial, technical and economic state of the enterprise and the expected internal possibilities for its development in the future.

Determining internal value involves the analyst identifying the most effective prospects for the development of the enterprise, the effect of system integrity, when the value of the whole is usually higher than the simple sum of the costs of individual elements.

In a civilized stock market, experts distinguish between the exchange rate and internal value of shares. The intrinsic or real value of a stock is the value that a stock should and will have when other investors receive information about the company that an expert appraiser has for that company.

The intrinsic value of an enterprise depends on:

The value of the enterprise’s assets, the degree of their liquidity;

The probable future profit of the enterprise, when predicting which a specialist analyst analyzes several options for the volume of profit received, choosing for evaluation the option with the highest degree of probability;

The dividend policy of the enterprise and, first of all, the level of financial leverage, showing the percentage of dividend growth when profits increase by one percent;

Prospects for the development of the enterprise (probable future growth rates).

The consideration of these factors is carried out in the process of fundamental analysis, the expected profit is the most important variable in this analysis, but other variables can also be taken into account: capital structure, quality of management, diversification of production, investment portfolio and others. The result of fundamental analysis is the substantiation of the internal fundamental value of the enterprise.

If the analysis reveals that the market (exchange) value of shares is lower than their intrinsic value, then the expert analyst concludes that the shares of this company are profitable to buy, and vice versa.

Liquidation value represents the net amount that the owner of the enterprise can receive upon liquidation of the enterprise and the separate sale of its assets.

There is a distinction between orderly liquidation of an enterprise and its forced liquidation.

Orderly liquidation is liquidation by decision of the owners of a given enterprise. The process of selling the assets of the enterprise is carried out within a reasonable period of time (the assets of the enterprise are being prepared for sale) in order to obtain the maximum possible price in these cases for each type of separately sold asset.

Forced liquidation is the liquidation of an enterprise by a decision of an arbitration court in the event of its bankruptcy or by a decision of an authorized management body in the case of the production of unauthorized products, violation of environmental standards, etc.

Compulsory liquidation means that assets are sold off quickly, usually in a single auction sale.

When calculating the liquidation value, it is necessary to take into account all the costs associated with the liquidation of the enterprise: current costs of maintaining the work and protecting the enterprise until its final liquidation, tax payments, payments for legal, appraisal, audit, brokerage services, etc. In addition, when calculating the current value of the enterprise As a liquidator, the expected net proceeds from the sale of assets must be discounted at a rate that takes into account the risk involved from the time the net proceeds are expected to be received until the valuation date. In the event of forced liquidation, the discount rate takes into account the increased risk of not receiving expected revenue due to the sale of the company's assets, usually at one auction. Accordingly, the liquidation value of the enterprise as a whole is usually inferior to the amount of proceeds from the separate sale of its assets.

The feasibility of reorganizing a bankrupt enterprise is determined by how much its value as an operating enterprise exceeds its liquidation value. Determining the value of a bankrupt enterprise for the purpose of its reorganization should be based primarily on forecast estimates, since it was its past activities that led to bankruptcy.

In addition to the listed cost standards, there is a wide variety of types of cost that can also be the subject of assessment.

Collateral value– the value of the asset that the lender hopes to receive from the sale of this asset on the market in the event of insolvency of the borrower.

Insurance value– this is the value of the object, determined for insurance purposes and reflected in the insurance contract (policy). The insurance value is calculated element by element, which is necessary to assess insurance compensation. Typically, the insured value is determined as replacement cost, since after an insured event the policyholder has to restore his property by purchasing new one.

Initial cost– this is the cost of creating or acquiring an enterprise (its individual asset) in prices of the year when the enterprise (asset) was created (acquired). The initial cost shows the actual costs of creating (acquiring) an enterprise (asset). For machinery and equipment, the initial cost includes the purchase price of the equipment and the costs of transportation and installation on site.

Full replacement cost– the cost of reproduction of an enterprise (asset) in modern conditions. The full replacement cost shows the current value of an enterprise (asset) created (acquired) earlier. In accordance with regulations on the revaluation of fixed assets of an enterprise, an expert appraiser must determine the full replacement cost.

Residual or residual replacement cost of an enterprise- this is its original or replacement cost minus the monetary value of all types of wear and tear: physical, moral and economic. Shows the actual value of the enterprise at the time of valuation.

Book value of the enterprise is the value of its assets according to the company's most recent balance sheet. The net book value of an enterprise is defined as the difference between the assets of the enterprise (at book value) and accumulated depreciation, as well as the liabilities of the enterprise.

The concept of going concern value is not a standard or type of value, but an assumption regarding the state of the enterprise. It means that the enterprise is assessed as a viable operating business entity that is not under immediate threat of cessation of activity. Thus, in many cases, in relation to an operating enterprise, it would be more correct to define the assessed value as the reasonable market value of the enterprise as an operating one, or as the investment value of an enterprise as an operating one, etc.

The goal of financial management of a firm is to sustainably increase the economic wealth of its owners or shareholders. What determines this well-being? Much. And not only economic. We will proceed here from the fact that the prosperity of the business in which you have invested your money is one of the best remedies for neurosis. In other words, the more expensive a company is valued by the market and the more stable this valuation, the higher the economic well-being and peace of mind of its owners. So, one of the fundamental questions to financial science and practice is: “How much is the company worth?”

Point of view

The answer to this question depends on from what point of view the company is assessed? The welfare of its owners is sometimes achieved in unexpected ways - for example, by selling the company. The valuation of a company depends on many other factors. There was even a special profession, “commercial property appraiser,” which in recent years has quickly been introduced into Russian business practice. Even a Russian association of appraisers has been organized. Similar associations have existed for many decades in countries with developed market economies. In addition, independent valuation firms exist as a developed business of consulting firms.

The value of a firm depends on what the valuation is for. There is no universal methodology in this area.

The more precisely the purpose of the assessment is defined, the more successful the project for which it was carried out will be. The company's value can be assessed:

• as an assessment of the value of a gift, fortune, estate for tax purposes;
• as the basis for plans for the participation of the company’s employees in its share capital (iployee Stock Ownership Plans, ESOP);
• when buying and selling a company or a block of its shares;
• upon liquidation of the company;
• during mergers and separation of companies;
• during financial takeovers and reconstruction of ownership of the company;
• when applying for a bank loan secured by the assets of the company;
• in case of divorce;
• when concluding insurance contracts;
• upon the occurrence of insured events;
• when declaring bankruptcy;
• when issuing new shares and other securities.

The value of the company itself can take different forms:

1) fair market value(fair market value) - that is, the value accepted by government agencies is equally beneficial to both small and large shareholders and is close to the average market value of similar objects;

2) investment cost(investment value) - i.e. the value of a given company for a given investor with all his plans, preferences, tax features, possible synergies and restrictions;

3) intrinsic or fundamental value(intrinsic, fundamental value), defined as an assessment obtained as a result of a careful and coordinated study of all characteristics of the company and market factors;

4) cost of continuing business(going concern value), upon receipt of which the appraiser believes that the company will continue to operate indefinitely;

5) liquidation value(liquidation value);

6) book value or book value(book value) obtained on the basis of accounting documents about the company’s assets and its liabilities;

7) fair market value(market value), i.e. the price for which a company can be sold within a reasonable time on the currently available market.

It is also worth keeping in mind the differences that exist between firms of different legal forms: private firms are valued differently than small joint-stock firms, and differently than huge corporations whose shares are constantly traded on stock exchanges.

What is especially important to financial analysts and most practitioners is the intrinsic value of a firm's shares. Because owning shares means owning a company.

Intrinsic or fundamental value

When calculating the intrinsic value, the analyst tries to be realistic, without overestimating or underestimating his estimates against the real market conditions of supply and demand for shares. He has to take into account the following factors that can affect the value of shares:

• Firm's asset value(value of the firm's assets). The company owns various assets that can be sold, and the proceeds from sales are distributed among shareholders. When valuing from the perspective of a continuing business, this value is usually not taken into account, unless the company is found to have assets that are not needed for continuation of the main production. But even in this case, the excess is sold, and then the company is assessed. Although the excess assets cannot always be sold within the limited time frame of the project for which the assessment is made. In the latter case, this part of the assets is included in the assessment.
• Probable future interest and dividends(likely future interest and dividends). If a company must pay interest on a previously taken out loan or has already announced the payment of dividends, then this affects the price of shares.
• Probable Future Earnings(likely future earnings). This is the basis of assessment, the most powerful factor.
• Probable future growth rate(likely future growth rate). If a company has a bright future of strong, fast and sustainable growth, then its shares will definitely go higher.

Intrinsic value is calculated in order to compare it with the current market value or with the price that a serious buyer would offer for the company. The market is imperfect, that is, it does not immediately respond to changes in the company; its shares may be either undervalued or overvalued. The main task of the analyst is precisely to detect inconsistencies of this type in order to use them profitably when buying and selling a company, or in order to draw the attention of management and owners to the dangers of financial takeover or bankruptcy. Situations of underestimation and overestimation of a company by the market are temporary, so any assessment remains correct only for some time, the duration of which is unknown. Sometimes the market immediately reacts even to rumors about a particular company, and sometimes it does not recognize even very promising changes in companies for a long time. Why is this so? This is one of the problems to which financial science has not yet found a clear answer.

The intrinsic value method does not always work due to the following main reasons:

• The market is imperfect; it does not always immediately and adequately respond to changes in companies.
• There are companies whose success depends heavily on speculative factors and luck, and not on the depth and thoroughness of calculations. Some types of trading are like this.
• Some firms grow rapidly, and this growth is difficult to predict and estimate because it is influenced by factors such as fashion. You can recall the boom in sales of the Rubik's cube and the Tamagotchi electronic toy. The whole world seemed to go crazy because of them! And why?
• New products, technologies and sectors appear in the market from time to time. The economic parameters of these new phenomena, for a certain time, are not amenable to formal analysis.
• Sometimes the market experiences “black” Tuesdays, Thursdays and Fridays, when stock prices of the entire market simply fall into the abyss for no apparent reason. The good thing is that these periods are relatively short, although unpredictable.
• It is not always easy to incorporate cyclical fluctuations in the economy into rational analysis. These phenomena are too multidimensional and complex.
• Revolutionary upheavals in some countries can shake and even change the structure of the market.

One way or another, the financial benefits associated with owning a company or part of it (shares) come from the following sources:

• income or cash flows from underlying operations;
• income or cash flows from investments (interest on purchased debt instruments or dividends from mutual instruments);
• proceeds from the sale of assets;
• proceeds from pledge of assets;
• sale of shares.

The main financial variables when estimating the magnitude of these sources are:

• profits (income);
• cash flows;
• dividends or ability to pay dividends;
• earnings;
• revenue (receipts);
• assets;
• cost of capital (level of bank interest rates).

In some cases, the features of the transactions for which the valuation is made and other additional circumstances can significantly affect the result. Among these factors:

• the size of the block of shares from the positions and in whose interests the company is assessed (controlling, dominant, significant, small);
• the right to participate in management (voting rights);
• the ability to easily, quickly and without significant losses sell shares, their liquidity, i.e. the presence of an equipped and active market for them;
• legislative restrictions on transactions with shares (by the size of the transaction, by the right to a controlling stake, antimonopoly rules, restrictions on making certain types of decisions, restrictions on the rights of foreigners, etc.);
• restrictions on property rights;
• restrictions on changing the main activity of the company;

Methods for estimating the value of a company

The list of methods for valuing firms is quite long. These methods are worthy of study in a separate course. We will only briefly describe the essence of each of these methods.

Ability-To-Pay Method

Buyers evaluate how much a given company can service as debt if purchased with borrowed funds. Sellers use this method to calculate the maximum price that the cash flow generated by the company can support.

The logic of the method is as follows. The firm will produce a cash inflow of X rubles, available to pay for borrowed capital. This way, the buyer can borrow such capital, pay it back within a reasonable period of time, and then profit from the business. This means that the amount of borrowed capital is approximately equal to the price of the business. The calculation is made as follows. Cash flow forecasts are prepared for 7-10 years (or less, depending on the average payback period for capital investments in this industry and in this country). Outflows to maintain the business in working competitive condition are subtracted from the forecasted flows. The result will be a forecast of average cash inflows for maintenance and return of borrowed capital. On this basis, the amount that can be borrowed from the bank against this cash flow is calculated. Taking into account that the loan cannot exceed 75-85% of the total project amount, the total cost of the company is calculated.

Discounted Cash Flow Method

This method is used: when the purchase of a company is considered as an investment and is intended to be resold in a few years; when a company is bought with borrowed funds for the purpose of quick liquidation or resale; when a firm operates in a high-risk environment.

The calculation is made as follows. A cash flow forecast is drawn up for the entire period that the buyer intends to keep the company in his ownership. Business maintenance expenses, taxes and debt service expenses are deducted annually. The remaining yearly amounts are then discounted to today's date and added together. The resulting amount is added to the residual value of the assets expected at the end of the holding period and subtracted from the expected liabilities at that time. The result is close to the company's current price.

Capitalization of Income Stream Method

The method is applied to firms that produce sufficiently large after-tax income that can be attributed to a “goodwill” that exceeds the value of the firm’s assets. An “updated” forecast income statement for the next 12 months is prepared. Net operating income after taxes is divided by the required return that a potential investor would expect from any investment at that level of risk. All obligations of the company that the new owner of the company will assume are subtracted from the result. The result is equal to the value of the firm.

Excess Earnings Method

This method is used to value any profitable company. It is assumed that the company is worth as much as its assets are actually worth, plus its “good name” if the income is high enough.

Economic Value of Assets Method

The method is used for companies that are not particularly profitable, for companies with declining profitability, and also in cases where selling the company in parts is more profitable than its current operation. Independent experts estimate the real liquidation value of each asset separately, and the results are added up to form the price of the company.

Net Worth Per Books Approach

Rarely used. The price is determined by subtracting the amount of the firm's liabilities from the amount of its assets. This assessment is used as an additional argument in negotiations.

Internal Revenue Service Method

Used primarily to determine taxes on gifts, inheritances, etc. "Intangible assets" and liabilities are subtracted from the firm's assets. An additional stream of income from the “good name”, capitalized at the industry average “normal” rate, is added to the result.

Comparable Sales Method

It is used when there is reliable data on sales of similar companies, the financial documentation of which is available for analysis and verified by independent experts. Past transactions are compared with the company being valued and item-by-item refinements are made to answer the question: “How much would our company be worth if it were sold in the same way as its analogue?”

Price/Earnings Ratio Method

Mainly applicable to large joint stock companies whose shares are traded on the stock exchange. A number of similar companies are being selected. The ratio (C/E) of the market price of shares to earnings per share is calculated, and then the average value of these ratios. The after-tax net income generated by the company being valued is multiplied by the resulting average P/E ratio to give a version of the firm's price as the total price of all its shares.

Replacement Cost Approach

This method is used only for insurance purposes under the terms of a contract for full compensation of losses from an insured event. An independent expert estimates the cost of business restoration at current prices. An independent expert is needed because the concept of “full restoration” is not particularly clear.

Industry simplified approaches (Rule-of-Thumb Pricing Methods)

Some traditional industries have developed time-honored relationships that are often overly simplistic but are generally accepted in the industry. Although it is difficult to argue with such assessments, this must be done using other assessment methods.

Secured Loan Value Method

It is used only as a method for calculating the amount of loan that can be raised for the further development of the company after its purchase. Each asset of the company is valued separately, and the amount is multiplied by the average by which the banking industry multiplies the value of the asset when accepting it as collateral.

When calculating intrinsic value, the analyst tries to be realistic, neither over nor underestimating his estimates against the actual market conditions of supply and demand for the stock. He has to take into account the following factors that can affect the price of shares:

• – the value of the company’s assets ( value of firm's assets). The company owns various assets that can be sold, and the proceeds from the sales are distributed among the shareholders. When assessed from a continuing business perspective, this value is usually not taken into account unless the firm is found to have assets that are not needed to continue its core business. But even in this case, the excess is sold, and then the company is evaluated. Although it is not always possible to sell excess assets within the limited time frame of the project for which the assessment is being made. In the latter case, this part of the assets is included in the valuation;
• – probable future interest and dividends ( likely future interest and dividends). If a company must pay interest on a previously taken out loan or has already announced the payment of dividends, then this affects the price of shares;
• – probable future income ( likely future earnings). This is the basis of assessment, the most powerful factor;
• – probable future growth rate ( likely future growth rate). If a company has a bright future of strong, fast and sustainable growth, then its shares will definitely go higher.

Intrinsic value is calculated in order to compare it with the current market value or with the price that a serious buyer would offer for the company. The market is imperfect, i.e. it does not immediately respond to changes in the company; its shares may be either undervalued or overvalued. The main task of the analyst is precisely to detect inconsistencies of this type in order to use them profitably when buying and selling a company, or in order to draw the attention of management and owners to the dangers of financial takeover or bankruptcy. Situations of underestimation and overestimation of a company by the market are temporary, so any assessment remains correct only for some time, the duration of which is unknown. Sometimes the market immediately reacts even to rumors about a particular company, and sometimes it does not recognize even very promising changes in companies for a long time. Why is this so? This is one of the problems to which financial science has not yet found a clear answer.

The intrinsic value method does not always work due to the following main reasons:

• – the market is imperfect, it does not always immediately adequately respond to changes in companies;
• – there are companies whose success depends heavily on speculative factors and luck, and not on the depth and thoroughness of calculations.

Some types of business are:

• – Some firms grow rapidly, and this growth is difficult to predict and evaluate because it is influenced by factors such as fashion. You can recall the boom in sales of the Rubik's cube and the Tamaguchi electronic toy. The whole world seemed to go crazy because of them! And why?
• – New products, technologies and sectors appear on the market from time to time. The economic parameters of these new phenomena do not lend themselves to formal analysis for some time;
• – sometimes “black Tuesdays, Thursdays and Fridays” occur in the market, when stock prices of the entire market simply fall into the abyss for no apparent reason. The good thing is that these periods are relatively short, although unpredictable;
• – cyclical fluctuations in the economy are not always easy to include in rational analysis. These phenomena are too multidimensional and complex;
• – revolutionary upheavals in some countries can shake and even change the structure of the market.

One way or another, the financial benefits associated with owning a company or part of it (shares) come from the following sources:

• 1) income or cash flows from main operations;
• 2) income or cash flows from investments (interest on purchased borrowed instruments or dividends from share instruments);
• 3) proceeds from the sale of assets;
• 4) proceeds from the pledge of assets;
• 5) sale of shares.

The main financial variables when estimating the magnitude of these sources are:

• 1) profit (income);
• 2) cash flows;
• 3) dividends or ability to pay dividends;
• 4) earnings;
• 5) revenue (receipts);
• 6) assets;
• 7) cost of capital (level of bank interest rates).

In some cases, the specifics of the transactions being assessed and other additional circumstances may significantly affect the result. Among these factors:

• – the size of the block of shares from the positions and in whose interests the company is assessed (controlling, dominant, significant, small);
• – rights to participate in management (voting rights);
• – the ability to easily, quickly and without significant losses sell shares, their liquidity, i.e. the presence of an equipped and active market for them;
• – legislative restrictions on transactions with shares (by the size of the transaction, by the right to a controlling stake, antimonopoly rules, restrictions on making certain types of decisions, restrictions on the rights of foreigners, etc.);
• – restrictions on property rights;
• – restrictions on changing the main activity of the company, etc.

The fundamental value of a company is the actual value of the company's assets, taking into account its financial condition. The indicator is predictive in nature. Investors predict the parameters of the enterprise.

The work is based on financial and production information.

Fundamental value of the company and fundamental analysis.

The investor buys securities after analysis.

Basic indicators:

Revenue. This is the money a company receives from the sale of goods or services. A good investor pays attention to the dynamics of the decline. During economic crises, a decrease in revenue is quite normal. To determine a company's potential, it should be compared with its competitors. If the decline is stronger than others, this is a worrying sign for the company. If the drop is smaller, this is positive news. For example, during the period of the first sanctions, Lukoil showed a slight decline compared to other companies. This is due to the close ties between Lukoil and American business, while others did not have such a connection.

Assets and capitalization. Everything that the company owns. The accumulation of free cash in the previous period allows the company to use it to pay off debt or other obligations.

Production indicators. Pay attention to the dynamics. For example, for a company that produces software, the number of copies sold is important, and for an oil organization, the primary indicator will be the amount of oil produced and processed.

Geopolitical factors.

Large companies inevitably depend on geopolitical factors. For example, Russian oil companies that have entered into contracts for the joint development of Venezuelan fields may lose them.

The fall in the performance of Russian organizations entails an increase in the value of American ones. A good investor takes into account less noticeable indicators: labor and tax laws, environmental laws.

The adoption of new environmental standards in Europe has closed the way for Russian petroleum products. Companies had to modernize factories and increase the level of oil processing in order to gain access to the European market.

Another example. Foxconn uses cheap labor. Its fundamental value will decline if legislation is passed that sets the minimum wage high enough.

Peculiarities.

The fundamental value of a company is a predictive indicator. It is not fixed anywhere and is determined by the intellectual work of the investor.

A good investor necessarily takes into account enterprise factors, industry, national and international parameters.