How is Company Valuation Done?

The question of how valuable a company is is not only crucial for investors but also for company owners, managers, and potential partners who frequently seek answers. Before making accurate decisions regarding an acquisition, merger, IPO, or investment, knowing the actual economic value of a company is of great importance. This is where “company valuation” comes into play. This process aims to numerically assess the company’s market position by analyzing various key variables, including financial data, management quality, sectoral competition, and growth potential. It draws a roadmap not only for today but also for the future. So, what exactly is company valuation, by which methods is it carried out, and how do these data shape investment decisions? Let’s explore the fundamentals of company valuation together.

What is company valuation?

The process of determining a company’s economic value through a comprehensive analysis is called company valuation. While conducting this analysis, several factors are taken into consideration, including financial status (assets, liabilities, income, and cash flow), operational performance, management quality, and the company’s market position. It can be said that company valuation is a vital tool that enables you to make informed decisions about the “true” economic value of your company or a company you are investing in. Multiple methods can be employed to analyze a company's monetary value.

Methods used in company valuation

Every method used in company valuation naturally has its strengths and weaknesses. The most reliable valuation typically emerges from combining these methods. These methods can be listed as follows:

Discounted cash flow (DCF) method

Focusing on the company’s cash generation potential, this method discounts the free cash flows expected to be generated by the company in the future to their present value. In the analysis, cash flow projections, the discount rate (usually the Weighted Average Cost of Capital, or WACC), and terminal value are calculated. Since this method projects the company’s future, it offers an in-depth analysis. It is commonly used in public or private company valuations, investment decisions, merger and acquisition analyses, and capital budgeting applications. In the DCF method, the risk of deviations in results due to errors in forecasts, as well as the sensitivity to discount rates and growth assumptions, should be taken into account.

Multiple analysis

Instead of focusing directly on cash flow, this method relies on industry standards and estimates company value by applying the median of specific financial ratios through comparison with similar companies. This method, which is quick to use and easy to understand, produces value through market-based comparisons. It is especially preferred for publicly traded companies when a quick market overview is needed, and ratios such as EV/EBITDA are frequently used in this method. The disadvantage of this method is that selecting truly comparable companies can be challenging. In addition, multiples may reflect market misperceptions.

Asset-based method

The company’s net asset value is found by subtracting liabilities from the market value of all tangible and intangible assets. This approach takes into account the updated values of assets and liabilities in mass applications. Typically preferred in asset-heavy businesses, such as real estate and manufacturing, or companies experiencing financial difficulties or in the process of liquidation, this method offers a concrete and straightforward basis; therefore, it is considered suitable for asset-intensive companies or those undergoing liquidation. The disadvantage of this method is that it does not account for future income potential. Moreover, it may not reflect intangible assets such as goodwill and brand value.

Factors considered in company valuation

The factors considered in company valuation can be classified as follows:

Financial performance

Continuous growth in the company’s revenue increases investor confidence. Additionally, having high profitability ratios is another element taken into account in valuation. Moreover, having a solid and predictable cash flow is also a positive indicator of the company’s ability to create value.

Growth potential

Opportunities in growing sectors increase valuation. Furthermore, investors assign greater value to companies that can grow with low incremental costs and continue to innovate.

Sectoral position and competitive advantages

In company valuation, having a strong brand, high customer loyalty, and competitive advantages are taken into account. Especially in merger and acquisition processes, strategic alignment enhances performance.

Management quality and corporate structure

An experienced and reliable management team reduces risk, while being prepared for legal, operational, and environmental risks helps prevent value loss.

Asset and capital structure

Assets such as real estate and patents are valuable. Additionally, while excessive debt creates risk, having an appropriate leverage provides tax advantages.

Market & macroeconomic conditions

During periods of uncertainty, fluctuations in value can be observed—additionally, a well-functioning M&A market and low-cost capital support company value.

ESG and corporate social responsibility

ESG performance can have a positive impact on both reputation and financial risk.

Interpreting valuation results

Company valuation results represent not only a numerical output but also how this output is interpreted and how it will guide investment decisions. For example, if a company’s value is high compared to its market value, investors may interpret this as “overvalued” and approach with caution. Conversely, if the valuation is below the market value, this may be perceived as a “value opportunity”; however, in such cases, potential risks must be carefully analyzed. Valuation results enable investors to compare return expectations with the associated risks. At this point, financial assumptions such as the discount rate form the basis of investment decisions.

Moreover, investor behavior, psychological biases, and market perception can make it challenging to interpret valuation results effectively. Factors such as herd mentality or excessive optimism may cause deviations from the company’s actual value. Comparisons made through multiple analyses (such as EV/EBITDA or P/E ratios) help to establish a relative position with other companies. Still, it should not be forgotten that this method may vary according to sector dynamics. Additionally, performing scenario and sensitivity analyses is crucial for predicting how the company will perform under different economic conditions.

Valuation results are also used in strategic decision-making processes. In sales, partnerships, IPOs, or new investment decisions, valuation serves as a reference point and provides a strong foundation for negotiation. In conclusion, company valuation is not just about producing a figure; it must be analyzed in a multi-dimensional way by associating this figure with the underlying assumptions, market conditions, strategic alignment, and investor objectives. Therefore, investors should interpret valuation results not only financially but also by considering sectoral, strategic, and behavioral factors when making decisions.

 

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This blog post contains general information, not legal, financial, or investment advice. The content is prepared for informational purposes only, and you are advised to seek professional advice for your specific circumstances. The expressions in this article do not carry any binding nature or responsibility and reflect only the author’s evaluation. All your decisions are your responsibility, and Papel Electronic Money and Payment Services Inc. accepts no liability for any consequences arising from them.