There are 3 popular ways to value a company. The first is comparable trading analysis. In this method a company is compared with other similar companies in the same industry. And various metrics of these companies are compared to each other to understand what the original company is worth. For example, let's assume the revenue of your company is $100 million, and let's also assume that there is another company in the same industry whose revenue is $200 million.
Nov 01 2013 11:02 AM
Now if the $200 million company is valued at $1 billion that means the valuation is 5x revenue. Because, 5 into $200 million is $1 billion. So there, the trading multiple for that company is 5 times revenue. So, what you would typically do is use that revenue multiple on your company. So your company's revenue is $100 million, so you applied a 5 times revenue multiple. So 5 into a $100 million is $500 million, which is the valuation of your company.
The second most common way of valuing a company is what is called comparable acquisition valuation. In this method you will look out for other companies in the same industry who have been acquired by a larger company and you will find out what valuation has that company been acquired for. And based on that valuation you will also determine a trading multiple, just like in the first scenario and you will apply that trading multiple to your company and hence you will get the valuation of your company.
For example in one of your competitors was acquired for $500 million and their revenue was $50 million, so then the revenue multiple for acquisition is 10x, because 500 divided by 50 is 10 times. So 10 times revenue somebody paid to buy this company. You will apply the same 10 time multiple to your company's $100 million and, hence, your company's valuation will be $1 billion.
The third and the most common way to value a company is what is called discounted cash flow or DCF. In this scenario you will project out the cash flows for a company into the future and you will discount those cash flows to today's value using appropriate discount rate and based on that you arrive at the equity value of the company. Typically, bankers and investors and executives use all these 3 methods to value a company and they finally average it out to get one valuation