The best way to calculate company value is by computing the future
cash flows of the company and discounting them back to today. However,
in order to do that, one would need historical cash-flow and profit
data, as well as the store-specific data mentioned by ireicm below.
While a DCF valuation is preferable, you do have enough information to
at least come up with a ballpark estimate on the valuation based on
the valuation of comparable companies. I caution you, however, that
using comparables to determine value is an inexact science at best,
because various financial and company-specific factors make it nearly
impossible to find a truly comparable business. The fact that you
don't have a number for profits is also disturbing, as the
price/earnings ratio is one of the most commonly quoted valuation
measurements. In addition, there are many ways to calculate cash
flows, and the store in question is under no obligation to use
generally accepted accounting principles (GAAP).
I'm going to estimate the business value based on the price/sales
ratio and the price/cash flow ratio. Again, these metrics vary greatly
from company to company, but the median value for the industry should
provide some guidelines you can use to value this liquor store.
According to your numbers, the store's price/sales ratio is 0.48, and
the price/cash flow ratio is 4.6.
Since financial data about private companies is, well, private, I used
data about public companies as an industry benchmark. Specialty
stores, a group that includes anything from pawnships to auto-parts
sellers to music stores to furniture stores, average a price/sales
ratio of 0.80. However, that average is skewed upward by a few very
expensive companies. The median price/sales ratio is 0.46. That means
that half of the companies have a higher P/S ratio, and half have a
lower ratio.
Privately held companies are generally worth no more than 80% of a
comparable public company, and often much less. The illiquidity of an
ownership stake warrants a substantial discount. In addition, a liquor
store, simply because of the nature of its products and the stigma and
excess taxes and regulation on those products, will trade at a
discount to most specialty stores. Makers and sellers of liquor and
tobacco traditionally trade at a discount to makers and sellers of
less-objectionable products.
Given the factors above, your store is far from a bargain.
The price/cash flow number looks a bit better. Your store has a P/CF
ratio of 4.6, while the median ratio for publicly trades specialty
stores is over 10. However, the same statements I made above about
illiquidity and industry-specific factors still apply. And I still
can't get past the fact that your cash flow number may be way off,
depending on what the owner excluded from earnings to derive it.
Receipts, or sales, is the cleanest number available to you, and based
on that number, the store might be a bargain at half the price. And it
might not. As I said earlier, this is an inexact science, and you
don't have much to work with. You responded to the commenter asking
whether there was a general formula. Well, there is -- it's the
discounted cash flow I talked about earlier. To use that formula,
however, you need a lot more information that what you provided here.
Below this answer, I've provided some information on that method if
you wish to pursue it.
For the record, I would strongly advise anybody against making a
purchase of this magnitude without a lot more data than you have
provided. Historical cash flows, profits, and sales are a must,
preferably 10 years of quarterly data, so you can track the movement
of profit margins and spending trends. If sales have been rising at
about 4% a year and profit margins are rising, then the store may be a
good buy. But what if sales have been flat, and margins are falling?
All you have to go on is a snapshot of the company's finances at a
particular moment in time -- and a grainy snapshot at that. It tells
you nothing about the future. As an example, consider a baseball
player who hit 30 home runs and drove in 100 runs last year. Sounds
like good production. First, assume he's 26 years old, and his homers
and RBIs have risen every year for the last three. Then, assume he's
36, and his homers and RBIs have fallen every year for the last three.
Which one deserves a bigger contract?
Before making a move, I'd also advise you to analyze the local market
to determine whether the business is likely to grow. Retail businesses
can be hurt by a range of factors, from a shift in the average age of
the population in its area to the opening of a Sam's Club a block away
to a new City Council with a hankering to change zoning ordinances.
And when you're talking about spending more than $200,000 for a store,
you definitely want to plunk down a thousand or so for an accountant
to look at the books. If the seller will not provide you with at least
five years of historical data on sales, profits, cash flows, and
inventories, don't return his calls. There are lots of stores for
sale.
I hope this helped you,
V.
Search strategy: None. I own some books on this topic, and I have
access to a database of financial information, which I tapped to come
up with the valuation estimates.
Warning: Gratuitously complicated section ahead!
If you're interested in discounting the cash flows, read on. I
answered a question about this for another Google client recently, and
I have copied a portion of that answer below.
The discounted cash flow valuation is the sum of the company?s cash
flows, discounted at a set rate to reflect the risk of those cash
flows. The formula for a discounted cash flow is written as:
CFt/(1+r)t -- The cash flow for period ?t?, divided by one plus the
discount rate, raised to the power of t. The value of the firm or the
equity stake is the sum of the future cash flows, usually representing
fixed amounts for five or 10 years, and an estimated terminal value.
For additional details about how the process works, check out
http://www.creativeacademics.com/finance/dcf.html#work
The difficulty here is not in the calculation, but in the assumptions
of future cash flows and the discount rate. The discount rate is
probably the most difficult to determine.
Once you have determined your inputs, the calculator at
http://www.creativeacademics.com/finance/dcf.html will calculate a
value for you. Alternatively, you could come up with ballpark
estimates for your company and calculate an estimated valuation that
will serve as a check on the other calculated values.
As for developing your assumptions, I cannot help you in detail. This
forum is inadequate for providing instructions, as the determination
of the cost of equity, cost of capital, and cash flows are tasks both
complex and company-specific. The access you have to company financial
data and the quality of that data will determine the difficulty of
calculating the cost of capital and estimating cash flows. However,
any advice I give you without spending hours examining your company?s
books and familiarizing myself with its operations would have little
practical value. If your stake has a substantial value, I?d advise
hiring an accountant to help you determine the inputs. Alternatively,
if you have good data and don?t mind crunching numbers, I have
provided some links that can help you do the math. Warning: This is
not for the faint of heart.
http://www.business.com/bdcframe.asp?ticker=&src=http%3A//rd.business.com/index.asp%3Fbdcz%3Dil.l.ml.e%26bdcr%3D5%26bdcu%3Dhttp%253A//www.stern.nyu.edu/%257Eadamodar/pc/model.xls%26bdcs%3D9BD1C5E4-0CE0-47CA-9EFF-A1DCAE0F177020041262915615%26bdcf%3D6e258a3a-10e2-11d4-8f60-00d0b7473557%26bdcp%3D%26partner%3Dbdc%26title%3DAswath%2520Damadoran%253A%2520Spreadsheet%2520for%2520Choosing%2520Appropriate%
2520DCF%2520Model&back=http%3A//www.business.com/directory/financial_services/investment_banking_and_brokerage/mergers_and_acquisitions_manda/business_valuation_techniques/discounted_cash_flows_dcf/&path=/directory/financial_services/investment_banking_and_brokerage/mergers_and_acquisitions_manda/business_valuation_techniques/discounted_cash_flows_dcf
http://www.business.com/bdcframe.asp?ticker=&src=http%3A//rd.business.com/index.asp%3Fbdcz%3Dil.l.ml.e%26bdcr%3D3%26bdcu%3Dhttp%253A//www.stern.nyu.edu/%257Eadamodar/New_Home_Page/lectures/dcfinput.html%26bdcs%3D9BD1C5E4-0CE0-47CA-9EFF-A1DCAE0F177020041262915615%26bdcf%3D6e258a3a-10e2-11d4-8f60-00d0b7473557%26bdcp%3D%26partner%3Dbdc%26title%3DAswath%2520Damadoran%253A%2520Estimating%2520Inputs%252
0for%2520Discounted%2520Cash%2520Flow%2520Valuation&back=http%3A//www.business.com/directory/financial_services/investment_banking_and_brokerage/mergers_and_acquisitions_manda/business_valuation_techniques/discounted_cash_flows_dcf/&path=/directory/financial_services/investment_banking_and_brokerage/mergers_and_acquisitions_manda/business_valuation_techniques/discounted_cash_flows_dcf
http://www.valuatum.com/tutorials/dcf_valuation.shtml
http://bluechips.uchicago.edu/dcfinput.pdf
Notice that the name of Aswath Damodaran keeps coming up. He?s the hot
writer on this topic, having written several books on asset valuation.
If you?re serious about discounted cash flow valuation, it may behoove
you to purchase one of his books, such as ?Damodaran on Valuation,?
available for $32 at half.com
(http://half.ebay.com/cat/buy/prod.cgi?cpid=653235&domain_id=1856&meta_id=1)
or ?Investment Valuation,? available for $37.12 at half .com
(http://half.ebay.com/cat/buy/prod.cgi?cpid=1068454050&domain_id=1856&meta_id=1). |
