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.

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