CHAPTER 5: MARKET VALUE APPROACH

Learning objectives:
1. To explain the applicability of using market value approach in business valuation.
2. To enumerate the various market value approach.

Methodology:
- Courseware/Limited face-to-face

Lecture/Discussion:
“Market value approach follows the concept that the value of the business can be determined by
reference to reasonably comparable guideline companies for which transaction values are known.”

Market-based valuation methods are routinely used by business owners, buyers and their professional
advisors to determine the business worth. This is especially so when a business sale transaction is
planned.

The market approach offers a view of business market value that is both easy to grasp and
straightforward to apply. The idea is to compare your business to similar businesses that have actually
sold.

All business valuation methods under the market approach fall within one or more of the following
categories:
1. Empirical / Statistical Approach (Use of research and database)
➢ It generally uses research and database processing in order to come up with conclusion and
recommendation.
➢ This approach requires references and evidences to support the determination and evaluation.
➢ Information may take the form of Sales Data, Financial Performance and other historical
information.
➢ Trend analysis and benchmarking maybe used to process the information.

A. Comparative Private Company Sales Data

✓ This is an empirical approach.
✓ This is formerly known as comparative transaction method.
✓ Other literature called this as guideline transaction method or comparative business sales
data.
✓ This method involves finding out prior transactions (i.e., mergers and acquisitions,
divestiture, etc.) of comparable companies.
✓ The advantage of this approach is that source data is reliable and comparable data includes
sales of small businesses that can be similar the small business being valued.
✓ The disadvantage however, is that it is costly to apply since the information you will gather
could have subscription fees. Among the most widely used are:
• Institute of Business Appraisers (IBA)
• BIZCOMPS ®
• Pratt’s Stats TM
• Done Deal TM
• Mid Market Comps TM (ValueSource)
• Mergerstat ®
B. Guideline Public Company Data
✓ This method involves identifying a comparable company and obtaining the stock price for
the company’s listed securities.
✓ The advantage of this approach is that there are plenty of transaction data available from
the public capital markets.
✓ The information may be gathered at SEC Website or Philippine Stock Exchange.
C. Prior Transactions Method
✓ This method involves looking up historical transactions in securities of the business under
valuation.
 ✓ The advantage of this approach is that it is already a good reference for valuation, if the data
is available. Since this is reliant heavily on the data, absence of a good data may not enable
this approach to produce reliable results.

Comparable Company Analysis

▪ It is a technique that uses relevant drivers for growth and performance that can be used as proxy to
set a reasonable estimate for the value of an asset or investment prospective.
▪ In determining the value using comparable company analysis, the following factors must be
considered:
✓ Comparators must be at least with the similar operations or in the similar industry
✓ Total or absolute values should not be compared
✓ Variables used in determining the ratios must be the same
✓ Period of observation must be comparable
✓ Non-quantitative factors must also be considered
▪ Financial ratios are used as tools to assess and analyze business results. These financial ratios are the
following:

A. Price – Earnings Ratio

➢ It represents the relationship of the market value per share and the earnings per share.
➢ It sends the signal on how much the market perceives the value of the company as compared to
what it actually earns.

Formula: P/E ratio = Market value per share ÷ Earnings per share

To illustrate, Chandelier Co. is a listed company with the market value per share of P12 and reported
earnings per share of P4.

Using the equation, the P/E ratio is 3. This means that the Chandelier Company can create 3x the
value of what it earns.

P/E ratio is also known as P/E Multiples or Price Multiples. To determine the value of a company
using P/E ratio, management accountants and analysts use P/E of the comparable company.

For instance, Jopet Hotels and Leisure is a hospitality company. Based on the income statement of
the company, it reported earnings of P7 per share. Based on the listed companies under hospitality
industry, the average P/E ratio is 4.25. With the foregoing information, you can expect that the
value of Jopet Hotels and Leisure is P29.75 per share [P29.75 = P7 x 4.25].

B. Book-to-Market Ratio
➢ It is used to determine the appreciation of the market to the value of the company as compared
to the value it reported under its Statement of Financial Position.
➢ It may be called that the book values of the company are based on historical costs and does not
purely incorporate the value in the market now.
➢ However, the only limitation of this ratio is that certain values incorporated do not represent
the true value of the company.

Formula: Book-to-Market ratio = Book value per share ÷ Market value per share

To illustrate, Chandelier Co. reported a book value per share of P35 and with a market value per
share of P12.50. The book-to- market ratio is 2.80 which is computed as follows:

Book to market ratio = P35 ÷ P12.50 = P2.80

This means that for every P35 per share that is owned by a stockholder it is 2.80x larger than its
value in the market.

If book-to-market approach is used for comparable company analysis, the key component of the
financial statement needed is the Statement of Financial Position. To illustrate, Jopet Hotels and
Leisure reported a book value per share of P16.5 and the hospitality industry average book-to-
market is 0.5, then the value of Jopet Hotels and Leisure can be estimated around P33 per share
[P33 = P16.50 / 0.5).
C. Dividend Yield Ratio
➢ It describes the relationship between the dividends received per share and the appreciation of
the market on the price of the company.
➢ It is also known as dividend multiple.
➢ This is also a popular tool because it provides the investors with the value which they can
actually get from the company.

Formula: Dividend yield ratio = Dividend per share ÷ Market value per share

To illustrate, Chandelier Co. declared and paid dividends of P1.50 per share and their market value
per share is P12.50. Based on the foregoing, the dividend yield ratio is 0.12 computed as follows:

Dividend Yield Ratio = P1.50 ÷ P12.50 = 0.12

This means that for every P1.50 dividends they pay it will translate into 12% of the market value of
the equity. Using this as a tool for comparable company analysis, DYR will works as a multiplier to
the dividends per share declared by the company.

Suppose that Jopet Hotels and Leisure declared P1.5 per share and the average dividend multiple of
the similar industry is 0.047. The market value per share can be estimated to be around P31.91 per
share [P31.91 = P1.50 / 0.047].

D. Dividend Paying Capacity Method

➢ This method links the relationship between the following variables:
a. Estimated amount of future dividends that can be paid out (based on historical earnings and
dividend payout of the business)
b. Weighted average dividend yields of comparable companies
c. Estimated value of the business

Formula: Value of the business = Future dividends ÷ weighted average dividend yields

E. Dividend payout ratio

➢ It shows the ratio of dividends paid out to shareholders over the earnings of the company.
➢ It answers the question, what percentage of the company’s earnings were distributed to owners
as dividends.

Formula: Dividend payout = Dividends ÷ Earnings

F. EBITDA Multiple
➢ It represents for the net amount of revenue after deducting operating expenses and before
deducting financial fixed costs, taxes and non-cash expenses.
➢ It can serve as a proxy of cash flows from operating activities before tax.

Formula: EBITDA Multiple = Market value per share ÷ EBITDA per share

EBITDA per share is derived by dividing EBITDA by outstanding share for common equity or ordinary
shares.

To illustrate, Chandelier Co. reported EBITDA per share of P6 and the market value per share being
P12. Given the equation the EBITDA Multiple is 2 [2 = P12 / P6].

This means that the value of the firm to the market is 2x for every peso of EBITDA earned.

In practice, others adjusted the EBITDA to incorporate costs relative to other quantified risks. This is
done by adding more costs or recognizing contingent expenses to generate a more conservative
EBITDA results which will serve as driver for the value of the market.

To illustrate, Jopet Hotels and Leisure reported an EBITDA multiple of P8.50 per share. The average
EBITDA multiple of the hospitality industry is 3.5. Given the foregoing, the value of the equity is
about P29.75 [P29.75 = P8.50 x 3.5].

To illustrate further, it also assumed that will have to procure insurance and security costs to protect
the plant assets of the company. This is about P0.5 per share. Given this additional information on
the foregoing, the value of equity is P28 [P28 = (P8.50 – P0.50) x 3.5]. You may note that the value of
the firm decreased by P1.75 [P1.75 = P29.75 – P28] after the risk management cost is incorporated.
2. Heuristic Pricing Rules Method (Use of expert opinions of professional practitioners)
➢ In this method, analysts use business pricing formulas that are developed based on the expert
opinion of professionals involved in business sales.
➢ The advantage of this approach is that pricing multiples based on the expert opinion of active
market participants is made available. Also, pricing formulas are often relied upon both by
practitioners and their client business owners and buyers when pricing a deal.

Book reference: Valuation Concepts and Methodologies, Lascano, Baron and Timothy - 2021 edition

--- END OF LECTURE NOTES ---