share:

Warren Buffet is quoted as saying “Price is what you pay, value is what you get.” Mr. Buffet is one of the most successful investors of all time, hence it is probably worth paying attention. In considering what this quote means, we first note that price represents what actually occurs as a result of specific supply and demand conditions at any given point in time. Value, on the other hand, is an economic concept that equates all future benefits from owning an asset into a single current amount. Therefore, there are times when price and value may diverge. In this article, we consider the difference between “price” and “value” and suggest practical considerations for valuation practitioners.
The price of an asset at any given point in time may be impacted by contemporaneous demand and supply considerations. Below are a few reasons price might differ from value:

  • Abundance of buyers
  • Crisis/worry/panic
  • Emotions
  • Excitement/euphoria
  • Fear of missing out
  • Greed
  • Government regulation
  • Inexperience/lack of knowledge
  • Lack of information
  • Motivations/special interests
  • Perceived benefit
  • Shortage of sellers

As valuators, how do we avoid letting temporary supply and demand conditions impact our appraisals? First, it must be remembered that value, at its core, is equal to the present value of future expected cash flows to be generated by an asset. Both the future cash flows and the appropriate discount rate have subjective components; hence, value is always rangebound. But there are ways to ensure that the final output remains within a reasonable range of intrinsic value.

Price, at times, presents valuators with a dilemma. The most prescient example of this occurs within the market approach to valuation, wherein one might observe a group of comparable companies trading at very high multiples of earnings, revenue, etc. Certain considerations in the aforementioned scenario for the valuator include the following:

  1. Prepare multiple valuation approaches and place more emphasis on an income approach: The income approach directly considers the future cash flow generating capacity of a company and therefore may be thought of as a measure of intrinsic value. Current capital market conditions are captured in part via estimating the subject company’s prospects (cash flows) and in part by way of the cost of capital, or discount rate, used the determine present value which contemplates current market conditions (e.g., interest rates, beta of comparable companies, etc.). The indication of value emanating from an income approach may be assigned an outsized weighting, or perhaps used exclusively in certain cases.
  2. Eliminate outlier guideline companies: While one or more guideline companies may be trading at abnormally high or low multiples, it is unlikely the entire group of comparable companies is impacted by temporary supply and demand factors. Therefore, the analyst should review individual guideline companies and try to identify the relevance of trading multiples. To the extent trading multiples are clearly impacted by price, the associated guideline company may be de-emphasized or eliminated.
  3. Pursue reasons for current supply/demand conditions: In some cases, an entire industry might be impacted by a particular set of conditions, an expectation, a regulatory matter, etc. For example, a widely expected tax credit might impact most participants in a particular industry. Once identified, determine whether the degree of impact on the subject company is similar to, greater than, or less than the market basket of comparable companies and adjust accordingly.
  4. Examine sale/merger multiples: The market approach often involves a comparison using publicly traded guideline companies. However, another form of the market approach involves using sale/merger multiples as valuation barometers. An examination of sale/merger multiples may provide valuable insights for pricing a private business when public market conditions are limiting. Of note, however, is that the analyst should be sure to make appropriate adjustments to sale/merger multiples if opining on a minority interest valuation, as well as endeavor to understand any differences that may be caused by supply/demand issues on the dates of such transactions.

The income approach is not void from considerations that sometimes impact price. The most common examples may be euphoria or perceived benefit, wherein management teams are overly optimistic regarding the subject company’s future prospects. As analysts, the best approach is to thoroughly investigate the financial projections. Select considerations relative to financial
projections follows below:

  • What is the bridge from historical financial results to projected financial results? For example, a company that has historically increased it revenue by 7% per year, on average, should have clear reasoning if a much higher growth rate is forecasted. Likewise, a company that has a historical operating margin of 20% should have clear reasoning for a future margin that is meaningfully higher.
  • Are the financial projections adequately supported both directly and indirectly? For example, if an abnormally high growth rate is forecast in a particular period, the analyst should ensure that such growth is directly supported by a sound business plan and also indirectly supported via sufficient funding (e.g., carefully examine the required capital expenditures, working capital, etc. as well as the associated funding sources).
  • How do the projections coincide with other market participants? For example, if projecting revenue growth in excess of industry competitors, why? Further, if a high growth rate in revenue is forecast, is the implied take on market share reasonable?

In conclusion, it is worth noting that Warren Buffet also said, “Beware of geeks bearing formulas.” To this end, a good appraiser will not be stuck in the proverbial analytical box, but rather will impart proper analytics to distinguish between price and value. MPI’s valuation professionals have decades of experience in valuing private companies and considering the relevant issues. Please contact us for more information.

About MPI

MPI, a prestigious national consulting firm founded in 1939, specializes in business valuation, forensic accounting, litigation support and corporate advisory work. MPI conducts every project as if it is going to face the highest level of scrutiny, and itssenior professionals have extensive experience presenting and defending work product in front of financial statement auditors, management teams, corporate boards and fiduciaries, the IRS, other government agencies, and in various courts. For additional information pertaining to MPI and our valuation and advisory services, visit www.mpival.com.

DISCLAIMERS: The information provided in this publication is only general in nature. It has been prepared without taking into account any specific objectives, financial circumstances or needs. Accordingly, MPI disclaims any and all guarantees, undertakings and warranties, expressed or implied, and shall not be liable for any loss or damage whatsoever (including human or computer error, negligent or otherwise, or actual, incidental, consequential or any other loss or damage) arising out of or in connection with any use or reliance upon the information or advice contained within this publication. The viewer must accept sole responsibility associated with the use of the material in this publication, irrespective of the purpose for which such use or results are applied. This material should not be viewed as advice or recommendations. This information is not intended to, and should not, form a primary basis for any investment, valuation or other decisions. MPI is not acting as a fiduciary, an expert or advisor in any capacity whatsoever in providing the information set forth herein. The information set forth herein may not be relied upon and is not a substitute for competent legal and financial advice. The viewer of this material is cautioned and advised to consult with his or her own legal and financial counsel in evaluating the information provided herein.

The information provided in this publication is based on public information. MPI makes every effort to use reliable and comprehensive information, but makes no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the information provided herein and MPI shall not have liability for any damages of any kind relating to any reliance on such data. Further, the information set forth herein is continuously subject to change and may fluctuate. MPI has no obligation to update the information set forth herein or to advise the viewer when opinions or information may change.

For Information, Please Contact:

Joseph C. Hassan, CFA, ASA

Managing Director 

(609) 955-5725

(908) 415-8012 (cell)

jhassan@mpival.com

Princeton Headquarters

1000 Lenox Drive

3rd Floor

Lawrenceville, NJ 08648

(609) 924-4200