Following are some of the practical difficulties that you might face while doing valuation and I have mentioned some ways to resolve it…
High Debt/Volatile Capital Structure: In case your firm has high D/E ratio, it has a very volatile debt structure then use Capital cash flow method to do your valuations..
Comparables: In case you can’t find data for the comparable company (To calculate Bottom up beta, to compare various multiples) in the industry or there are no real comparable company in the particular sector then expand your horizon..Move to closely allied sector and pinch some comparables from there..You can even get to pick some global companies and use them as comparables(Chose countries such as Brazil , China which have comparable growth rate as India or your sector should be in the same life cycle in that particular country)..This is little complicated stuff…I would not recommend to go to this level for an academic project (But just in case you end up in a valuation based role, impress your manager using this funda!!)
Choose the right model: In case your company is in a high growth stage: around 20-50%) then chose a three stage model..Two stage will not work in this case because you assume the high growth rate to be say 30% for 5 years..You can’t suddenly assume a stable growth rate of 7% from year 6(Because your growth will not fall so steeply)..So three stage model assumes a linear fall in growth from high growth rate to stable growth rate…And try to restrict yourself to three stage model..Going beyond three stage model will complicate things too much..Also when you are taking a three stage model make sure that you make different assumptions for the beta , ROE , ROA (Refer some typical examples in Damodaran Text book in FCFE chapter)..
Bank Valuation: In case you are amongst those poor souls valuing a bank , then the only thing I have to tell is that don’t go by the traditional methods of valuation like FCFE ..You have to be concentrating on factors like NIM for the projections (I don’t know how to do it!!)
Relative multiples :
· Ignore the value/ratio if you end up with a negative number
· In case of valuing ratios using fundamental values (Ke,g.payout) be clear that there are two different formulaes that are applicable: One for stable growth companies and other for companies in the high growth period..Use the appropriate formulae based on your company
· Use ratios which will make sense to your industry..For a technology company PEG ratio is a bare minimum and so is P/S , V/S for a FMCG
· In case you are picking numbers from database be clear which earnings figure they have used to calculate the ratio..(That would be the first q from the audience or from your boss when you present a multiple)
· In case data for a particular comparable company is not available, then don’t use that company in the ratio..Don’t do the mistake of comparing the ratio of your company in the current year with the ratio of the competitor in the previous year(It’ll make no sense..That too in the current scenario where the ratios have halved over the last one year)
Be clear with all your assumptions for your inputs:Valuation is a very subjective exercise..Hence you can take any number for your inputs..But make sure that every number you enter into your model is thoroughly backed up either fundamentals, analyst estimates, management discussion (directors report etc)..
Refer NSE website to get information regarding publicly traded bonds (to calculate the cost of debt of your bond: use the YTM of the bond if it is traded) and also to find the current RFR
Capital expenditures assumption
The projection for capital expenditure can be done in either of these ways a) Assume your Capex to be in proption of sales as in the previous year b) If there are some management estimates of the capex c) If there are some discussion about a big acquisition going to happen in the near future, then factor that into your Capex figure (Just a guesstimate!!)
Capitalise your assets/liablities
In case of an FMCG firm/Airways, don’t forget to capitalize the operating lease..You’ll end up with a figure which will be approximately 20% higher than the actual..Similarly capitalize R and D of a pharma company.