Valuation: The Market Approach


The market approach aims to establish the value of a company based on how similar firms are priced on the stock exchange or through company transactions. Using the market approach, price-related indicators such as price to earnings, sales and book values are utilised. An ever-present problem however, is that different valuation multiples and valuation methodologies tend to provide the analyst with contradictory outputs. The solution to this problem so far has been to claim that the market approach is more art than science, thus providing the analyst with the freedom to alter the multiples at their own discretion to reach a uniform value or range.

Valuation: The Market Approach puts an end to this problem, providing the reader with a rational scientific-based understanding and the necessary tools to perform a sound market approach valuation, or if reviewing such valuations, provide the tools to challenge the work of the arts-based senior experts.

The book begins with an in-depth review of the basics; which is then applied in a detailed worked example. Step-by-step, the reader’s expertise is built towards a complete understanding and implementation of the market approach, not only on a standalone basis but also in relation to the DCF methodology.

The book is aimed at the seasoned professional, but will also be invaluable to students as they apply their academic knowledge to the real world of valuation and M&A.

About the author:

SETH BERNSTROM is a Director at the Valuations practice of PwC. He has 15 years of experience as a valuation expert with a special focus on private equity, with long-running engagements in Valuation for some of the leading Nordic private equity houses. Additionally, he provides valuation support and valuation-related advisory services to large and medium-sized Nordic and (Nordic-based) global companies. In addition to his regular work at PwC, he also acts as Visiting Lecturer on valuation at KTH Royal Institute of Technology in Stockholm. Furthermore, he often gives lectures and seminars on valuation at other leading Nordic universities, investment banks, companies, and organizations. He holds a Master of Science in Business Administration and Economics from the Stockholm University School of Business.


Acknowledgments ix

Introduction 1

1 Corporate Valuation 5

1.1 The discounted cash flow approach 5

1.2 The market approach 6

1.3 The net asset approach 6

2 What Value? 9

2.1 Standard of values 9

2.2 Marketability and control 11

2.2.1 Marketability (liquidity) 11

2.2.2 Control 11

2.2.3 Adjusting formarketability and control 13

3 Exchange-traded Shares vs. Transactions 19

3.1 Exchange-traded shares 19

3.2 Transactions 20

4 How to Put the Peer Group Together 23

4.1 The selection process 23

4.1.1 Geography 23

4.1.2 Business model 23

4.2 How many comparables? 26

4.3 Analyzing the history 26

5 Market Value of Equity vs. Market Value of Operating / Invested Capital 29

5.1 Market value of equity 29

5.2 Market value of operating/invested capital 29

6 The Value Multiples 39

6.1 EV multiples 40

6.2 Pmultiples 42

6.3 Other details to consider 47

7 The Value Drivers 49

7.1 Primary value drivers of the EV multiples 49

7.2 Primary value drivers of the Pmultiples 50

7.3 Assumptions regarding value drivers 50

8 Applying the Market Approach in Practice 53

8.1 The case study 53

8.1.1 EV/Sales 56

8.1.2 EV/EBIT 79

8.1.3 EV/BEV 87

8.1.4 Some closing remarks 90

8.2 Risk 96

8.2.1 The discounted cash flow approach (DCF) 97

8.2.2 Forecasted cash flows 105

8.2.3 Cost of capital (discount rate) 106

8.2.4 Cost of equity (Ke) 107

8.2.5 The capital asset pricing model (CAPM) 107

8.2.6 Adjusted CAPM 114

8.2.7 Cost of debt (Kd) 118

8.2.8 Capital structure 119

8.2.9 Weighted average cost of capital (WACC) 120

8.3 Summary of calculated values 130

8.3.1 EV multiples 130

8.3.2 Price multiples - short tuning 131

8.3.3 Concluding remarks 137

9 Using the Market Approach for Reconciliation 141

9.1 The discounted cash flow value of Engineering Corp 141

9.1.1 EV/Sales 146

9.1.2 EV/EBIT 158

9.1.3 EV/BEV 165

9.1.4 Some closing remarks 166

10 Forward-looking Value Multiples 173

11 Summary and Concluding Remarks 181

12 Epilog 189

Appendix: Brief Derivation of the Respective Value Multiple's Individual Value Drivers 191

Index 197