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1. Why and When Are Companies Valued?
Valuing companies is a common business activity and a very useful skill for analysts to learn. This introductory lesson explains how and when company valuation is used during the course of business.
Valuation vs Price
- Valuation is not the same as price
- Price is the single amount agreed between a seller and a buyer
- However both sides will perform a valuation to arrive at the final price
- The same company can hold a different value for different parties (e.g. Whatsapp)
When Do We Value a Company?
- When a company is for sale
- When we want to buy shares on the stock market
- When a company is seeking to obtain a loan
- When a company is doing internal strategic planning
Methods of Valuation
- The 2 most popular methods of valuation we'll cover in this course are:
--- Income based valuation
--- Market based valuation
From the first course in this category, we began by analyzing the three financial statements of a company, which are the Income Statement, Balance Sheet, and cash flows statement. In the second course, financial projections, we used our knowledge of the business to create a set of assumptions that enabled us to create future projections of the three financial statements. These are often called pro forma financial statements. In this course, we're going to build on this work and establish a valuation from MarkerCo using a number of different techniques. Before we get started, it's important to learn why valuing a company is such a critical skill for would be senior management. First of all, it's important to remember that value is not the same as price. Price is the amount agreed between a buyer and a seller. A buyer will hope that the price is less than the value of a business, and a seller will hope that the price is more than the value of the business. While there is only one price when a company is being sold, a company can have different value to different participants. For example, WhatsApp was bought by Facebook for $19 billion even though WhatsApp at the time only had around $20 million in revenue. WhatsApp is certainly not worth $19 billion to me, but for Facebook, where WhatsApp was a rival social network with 100s of millions of users that could increased Facebook's reach into emerging markets, it could be worth a lot closer to that 19 billion. So when do we perform a valuation? Well the obvious example is when a company is put up for sale. When a company is for sale, performing a valuation helps the buyer figure out the highest price that she should pay, and valuation also helps the seller figure out the lowest price at which he should be prepared to sell the company. Other times a valuation is performed on a business include when we want to buy shares on the stock market, when a company is raising money from investors, for example, venture capitalists, when a company is seeking to obtain a loan, or when a company is doing some internal strategic planning and it wants to decide which business units should be sold, built, or even shut down. To obtain a position in senior management, a broad understanding of company valuation can be a huge addition to your skillset. As a serious student of business, it's absolutely critical that you understand the various methods of company valuation. While there are many ways to value a business, in this course, we're going to focus on the two most popular, income-based valuation and market-based valuation, which uses multiples. In the next lesson, I'm going to start off our analysis by explaining these different methods in much more detail. As this is our first company valuation course, I've left out some of the more complex concepts you might encounter when valuing a company. These include long-term debt, pension obligations, different classes of stock, how the transaction is funded, stock-based compensation for employees, the amortization of intangibles, potential share buybacks, and debt and equity issuance. In later courses, we'll be sure to cover all of these concepts in detail.