Our life as business valuation experts is not an easy one. We have to master capital market theory as well as well as statistics to derive proper discount rates. We have to understand taxation and commercial accounting rules in order to set up sound financial statement forecasts. We have to manage business model, competitive environment and boader market dynamics analysis in order to make or check cash flow projections, etc.
In theory, we could easily spend weeks or months with every single above-cited business discipline in every single valuation case. We could go deeper and deeper into every detail, run more and more analyses, approach the problems from yet another angle, etc. But in practice, things are quite different: Time and remuneration budget constraints, a lack of information availability and the general uncertainty about the future pose limits to our analytical efforts. And such limitations inevitably lead to our valuation works and outcomes being – by the very nature of practical circumstances – always a bit incomplete. This is quite an unsatisfying aspect of our work as valuation experts which ultimatively raises the question: how can we optimise the quality of valuation results in such an environment?
In 1970, Simon Ramo published a book called “Extraordinary Tennis for the Ordinary Tennis Player”. In this book he showed that amateur tennis is a typical loser’s game where most points are made by mistakes of the opponent player – in contrast to professional tennis where most points are made by winner shots. His advise to amateur tennis players: Just avoid making mistakes! In 1975, Charles Ellis demonstrated in his famous article “The Loser’s Game”, published in the Financial Analyst Journal, that equity investing is also a loser’s game: Due to the complexity of the world, investors do best by avoiding severe mistakes and not by trying to optime every single performance contributor. And business valuation is not different, it is also a loser’s game: The best valuation results in a world of uncertainty and complexity are achieved when keeping a holistic view rather than risking to make mistakes by wandering in a maze of details.
What does this mean for our work? While we certainly cannot fully ignore the many details of business valuation we should nevertheless step back at different points of our valuation process and have a look at the big valuation picture: Does this risk parameter really fit to our business model? Is this margin development seen at any other company in the industry? Do multiples support my DCF results? Does it all fit together? Only if we revisit these roots of valuation we can check whether it all makes sense. Don’t give away this important way of adding quality to your valuation results.
We hope you enjoy reading this EBVM issue and look forward to your feedback.
