How to calculate the valuation of a company?

For an investor, creditors, and shareholders, it is crucial to know the company's valuation before engaging their money in it. It is also crucial for the company to analyze its valuation when opting for availing business loans, IPO, or other similar capital structuring.

This article will revolve around how to find the valuation of a company and other details to help you all find the company's valuation when required.

What Is the Valuation of a Company?

Valuation of a company can be referred to as the process of determining the fair value of the company/ business which is also known as the intrinsic value. It is to understand the company/ business’s worth in the market. By following the process, one can understand whether a company is undervalued, overvalued, or at par.

Popular Methods Used for Company Valuation

While figuring out how you determine the valuation of a company, the most important part is to decide which method/s you can use. Here are all the methods used for a company's valuation.

Discounted Cash Flow:

The most popular method of a company's valuation is the discounted cash flow method or DCF method. This is regarded as the gold standard for valuation of companies. This method involves the determination of the company's value based on anticipated cash flows of the future. Under this technique, the future cash flows are discounted to find out the present value using a discount rate and a specific period for the analysis.

The company valuation formula using the DCF method is as follows –

Terminal Cash Flow/ (1+Cost of Capital) ^ Number of Year

The benefit of using the DCF method is that it focuses on the businesses’ ability to generate cash flows or liquid assets however, that can vary across the timeline. On the other hand, the challenge of using this method is that it is based on assumptions & and future cash flows and discount rates are all assumptions.

Asset-Based Approach:

Under this method, you need to calculate the Net Asset Value (NAV) of the company for the company's valuation. You need to use the fair value of all the depreciating and non-depreciating assets of the company. This method is mainly used for companies with more tangible assets.

To calculate NAV, you need to use this company valuation formula –

NAV = Fair value of both depreciating and non-depreciating assets – all outstanding liabilities

Using Price Earnings Ratio:

One of the most commonly used methods to assess a company's valuation is the Price Earning or

PE Ratio

. The stock price of the company is divided by the earnings per share, to see whether the company is undervalued, or overvalued. To avoid distortion, it is better to use earnings per share calculated from historical Profit after tax (PAT) rather than for a single period. The stock can be considered overvalued if the

P/E ratio

is higher than the sectoral P/E ratio, and vice versa.

P/E Ratio = Current Market Price/Earnings Per Share

EBITDA:

Another method for the valuation of companies involves analyzing EBITDA or Earnings before Interest, Tax, depreciation, and Amortization. To get a fair idea of the business performance, analysts consider EBITDA over net profit. The reason behind this is tax rate is the same across companies, interest depends on the capital structure of the company, and businesses having higher fixed assets have higher depreciation and amortization. This interrupts the actual operating performance of the business.

Market Capitalization:

Another easy way to find out a company's valuation is by calculating its market capitalization. For this, you just need to multiply the share price by the number of outstanding shares. This method easily determines the current valuation of the company. It also helps in understanding the financial health, business potential, and other external factors affecting the business.

Market Capitalization = Current Market Price * Number of Outstanding Shares

Enterprise Value:

This method helps in dealing with the different aspects of the capital structure to give you the valuation of the company. However, if the debt level is high then using enterprise value alone for valuation can be challenging.

Enterprise Value = Debt + Equity - Cash

Price to Book Value (PBV) Method:

This is one of the simplest methods used for a company's valuation. Similar to the P/E ratio, the PBV ratio indicates whether the company is fairly valued against its book value or not. It can be calculated using the following company valuation formula

PBV Ratio = Current Market Price/ Book Value of the Company

Present Value of Growing Perpetuity:

Often EBITDA is considered a growing perpetuity for companies. One can use this to find out the company's valuation too.

The formulae for the same is

Cash Flow/ (Cost of Capital – Growth Rate)

Price to Sales:

You can also use the Price-to-sales- ratio as it gives a better understanding of the company's valuation compared to the P/E ratio. This method can be used when the profits of the company are not consistent.

P/S Ratio = Current Stock Price/ Net Annual Sales Per Share

Book Value:

Finally, you can also determine the valuation of a business by its book value. However, this is not regarded as a significant method as the accounting methods can distort the assets and liabilities.

How to Calculate Company Valuation: Step-by-Step Examples

Let us understand how to figure out the valuation of a company by these examples.

Suppose Company A is a pharmaceutical industry leader with a major market share.

Details of Company A

• Current Market Price: Rs. 1000

• Total outstanding equity shares: 100000

• EPS: Rs. 10

• Terminal Cash Flow per share for the coming 5 years: Rs. 1500

• Cost of capital: 5%

Then you can find the valuation of the company by the following methods –

• Market Capitalization: Rs. 1000*100000 = Rs. 100000000

• P/E Ratio: Rs. 1000/Rs. 10 = 100

• DCF: [Rs. 1500/(1+0.05)^5) = Rs. 1175.54 per share. As per the DCF method, the intrinsic value is higher than the current market price so, the company is undervalued.

Why Company Valuation Matters for Investors

The importance of the company's valuation includes–

• Helps investors in making investment decisions

• It helps creditors analyze the credibility of the company

• Helps investors evaluate the company's potential

• Assist management in evaluating the performance of the business and analyzing the financial health of the company.

Conclusion

To conclude, whether you are an investor, shareholder, creditor, or the management of a company, valuation is important for everyone who wants to invest in the company. Since there are multiple methods of valuation, it is at the discretion of the person determining the value to choose the one, which suits the particular company, business nature, and industry.

FAQs on the Valuation of a Company

1. What is the formula for valuing a company?

There are multiple formulas for a company's valuation.

• DCF

• Asset Approach

• Book Value = Assets – Liabilities

• Growth Perpetuity

• Enterprise value = Debt + liabilities - cash

• P/E = CMP/EPS

• P/S  = P/S Ratio = Current Stock Price/ Net Annual Sales Per Share

• PBV = CMP/Book Value

• Market Value = CMP* total outstanding shares

• EBITDA = Net profit + Tax+ interest+ Depreciation+ amortization

2. What are the ways to value a company?

You can use the following methods –

• DCF

• Asset Approach

• Book Value

• Growth Perpetuity

• Enterprise value

• P/E

• P/S

• PBV

• Market Value

• EBITDA

3. Which is the best valuation method?

Every method is significant for the valuation of the company and it depends on the type of the business or the industry the capital structure and other factors that which method of valuation is the best for the particular company.