The Valuation Handbook: Valuation Techniques from Today's Top Practitioners

CHAPTER 4

Comparing Valuation Models

 

Thomas E. Copeland, Ph.D.

Founder, Copeland Valuation Consultants

 

 

Herein I focus attention on a seemingly simple question: “Which valua tion model is best?”¹² The marketplace, of course, determines the actual transaction prices of all types of assets in addition to companies—houses, automobiles, planes, racehorses, gems, artwork, first editions, and so forth. But the current market price can deviate from the fundamentals in the short run. Valuation models claim to provide equilibrium or intrinsic value estimates. How does one decide which valuation model is best?

A classic valuation approach has been to find a comparable asset that has traded recently and to adjust the comparable’s trading price to that of the asset being valued by scaling with an alleged value driver such as earnings. Unfortunately, while one-carat flawless diamonds are close substitutes to each other, a company in the chemicals industry with $5 billion of annual sales that grows at 4 percent a year may not be even vaguely similar to another chemical company with $50 million of sales that has been growing at 12 percent, even though their current earnings might be similar. In the past 70 years or so, comparables have been replaced with various discounted cash flow (DCF) models. Are they any better than comparables? How should one decide?

The measure of the quality of a valuation model depends on its intended use. For legal purposes, such as taxation, inheritance, and division ...