What to Read on Business Valuation?

Let me admit it, i am a business valuation novice. For most other people like me out there (or in here!), where do you suggest to find the best knowledge on this topic? While Real Estate valuation is something i’m more well-versed with, and have practiced as a profession, business valuation is a different game altogether!

(Featured image source : ShutterStock)

I came across a widely read publication by none other than “the firm”, McKinsey (wanted to start with a book outside of the ‘finance world’). Guess it’s good to start with because i have basic knowledge of finance (scouted a course on Coursera from Wharton) and have even done a hands-on course on financial modeling for investment banking. I keep using these fundamentals to study different businesses in different sectors from time to time. Balance Sheets, Cash-flow Statements, EBITDA, etc.. it’s more fun when you get to punch in the numbers while reading 🙂 😀

There! You thought i’d be something like a Pro (well i have a blog on finance – what am i even saying)? But then, why not start learning with me?! First lets take a look at the topics covered…

Part One – Foundations of Value

  • Chapter One : Why Value Value – i guess that’s an interesting and pertinent question to begin with!
  • Chapter Two : Fundamental Principles of Value Creation
  • Chapter Three : The Expectations Treadmill
  • Chapter Four : Return on Invested Capital
  • Chapter 5 : Growth (yes, upwards from here!)

Core principles of value creation are discussed in Part One. The first one is that return on capital and growth drive cash flow. Cash flow in turn drives value. Second principle is the conservation of value principle. It simply states that anything that doesn’t increase cash flow, doesn’t create value, unless it helps to reduce risk.

Part Two – Core Valuation Techniques

  • Chapter Six : Frameworks for Valuation
  • Chapter Seven : Reorganizing the Financial Statements
  • Chapter Eight : Analyzing Performance and Competitive Position
  • Chapter Nine : Forecasting Performance
  • Chapter Ten : Estimating Continuing Value – this is all the ‘technical’ stuff that’s been scaring me!
  • Chapter Eleven : Estimating the Cost of Capital
  • Chapter Twelve : Moving from Enterprise Value to Value per Share
  • Chapter Thirteen : Calculating and Interpreting Results
  • Chapter Fourteen : Using Multiples to Triangulate Results

As the name suggests, this is the technical section encompassing DCF (Discounted Cash Flow), analyzing a company’s historical performance, estimating opportunity cost of capital, and so on.

Part Three – Intrinsic Value and the Stock Market

Wait, did someone just say Stock Markets? I’m listening!

  • Chapter Fifteen : Market Value tracks Return on Invested Capital and Growth
  • Chapter Sixteen : Market Values Substance, Not Formwell, my newest, savviest start-up idea just flew out the window :O

  • Chapter Seventeen : Emotions and Mispricing in the Market
  • Chapter Eighteen : Investors and Managers in Efficient Markets

Now that’s more like a grown up! We complete an overview till Chapter 18 here. So we see that in Part 3, evidence is given in support of share prices reflecting core principles of value creation, and no influence of earnings management and accounting results. To a large extent, share prices are also not subject to institutional trading factors like Cross-listings (the listing of a company’s common shares on a different exchange than its primary and original stock exchange). This section culminates in telling about what makes stock markets efficient, the kind of investors that determine a stock’s trading range, and how they affect managerial decisions.

I’m using the 5th Edition of this book (Authors: Tim Koller, Marc Goedhart, David Wessels). I’ve heard a lot of experts say the market fluctuations don’t matter as long as you invest in the ‘right’ businesses, have correct valuations. Now I’m counting on this book, this holy grail, to help me out with that! What caught my attention the most? This one-liner by the authors –

“If we have done our job well, (the book) it will soon be full of underlinings, margin notations, and highlightings.

Any thoughts on other books/websites that structure the ideas equally well or better?  I’m stuck with the idea that we can’t really understand finance till we know businesses, and we can’t know businesses till we understand ‘value’ – because that’s what businesses are supposed to ‘create’! Please share your ideas in the comments below.

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