How should a company be valued? Many would say it’s up to shareholders to give value, but as anyone who has listened to CEOs deride current pricing, read analyst estimates or observed the merger and acquisition process, value is more often than not in the eye of beholder—and everywhere else.
“Honestly, I don’t think CEOs really do have a sense of what the value of their company is,” observes Richard Moore, a managing director with RBC Capital Markets in Cleveland.
Obviously, for publicly traded companies the market creates shareholder value but Moore was referring to intrinsic value and he wasn’t being facetious. The job of street analysts like Moore is to evaluate companies, but there are a lot of methodologies out there and different interested parties create variations of basic formulas to arrive at a corporate value. What the Street thinks of your company may be different from what an institutional investor looking to buy a piece of your action believes, which is why it is often helpful to always do your own in-house evaluation.
Accurate corporate valuation was extremely important to Richard Campo, chairman and CEO of Camden Property Trust, a Houston-based real estate investment trust, because up until mid-year 2007 he was operating in a takeover environment. For the prior two to three years, a number of REITs, in particular multifamily REITs such as Camden, were being taken private by institutional investors.
“At the time, the Wall Street value of REITs was significantly discounted compared to Main Street (private investor) value,” says Campo. “So, there was this arbitrage between Wall Street value and what was perceived to be break-up value and people came in, took advantage of it and made a lot of money.”
He adds, “the question of what is the value of your company and whether it is accurate depends on your view of the world going forward.” But, that’s a little misleading because in Campo’s sector, there are two basic valuation methodologies, net asset value and cash flow. Basically, net asset value is the total assets minus liabilities and it’s really a snapshot of what a company is worth.
Cash flow evaluations are something entirely different and this treads heavily in true-believer territory.
Tim Koller is a partner in the New York office of McKinsey & Co. and is a member of the leadership group of the firm’s global corporate finance practice. Koller has a certainty about corporate valuations and it is this: Only use discounted cash flow. Basically, the DCF approach to valuation uses the concept of time value of money, or a projection of cash flow that a company can generate. DCF, Koller adds, is “the most accurate and flexible method for valuing projects, division and companies.”
Koller recognizes that financial analysts often calculate an industry average price-earnings (P/E) ratio (valuation ratio of company’s current share price compared to its per-share earnings) to establish a “fair” value, but he sees that as just a “first cut” methodology.
“It’s always useful to do P/E ratios, but it’s important to go beyond that—and don’t forget there are a lot of different ways to do P/E ratios,” he says. “A lot of analysts talk about earnings because they are an indicator of cash flow, but where earnings and cash flow diverge, cash flow is more important.”
