Business valuation of private companies – where do the security analysts fit in?
Business valuation is a constant challenge for the business people and professionals alike. While many security analysts do not have the accounting background, they often engage in valuing companies.
Professionally managed firms, especially public companies, must adhere to the consistent financial accounting and reporting rules such as the GAAP mandated in the US by the Securities and Exchange Commission (SEC).
SEC discourages private discussions between the public company management and independent security analysts these days, so digging up additional information beyond the filed GAAP financials is not easy. Most significantly, the company’s financials disclosed to the public do not provide much guidance on the values of company’s intangible assets.
From the asset approach perspective, business intangible asset value is potentially a very significant contributor to the value of the business enterprise. So how can an analyst estimate the value of a business in the absence of information on the valuation of the patents and trademarks, internally developed technology, skilled workforce, distribution channels, and customer lists?
If you are skeptical about the ability of a valuation expert to come up with an accurate business valuation without such information, you are not alone.
Many seasoned analysts know this and defend their view of business value by claiming the understanding of the key value drivers for the target companies. In other words, an experienced analyst develops an insight into the underlying business assets that are not explicitly valued in the disclosed financial and operational statements.
Less experienced analysts could arguably be swamped by the flood of data on a company and fail to make sense of all the ‘moving parts’. They feel that the accounting statements they have access to are about all they can handle in order to estimate business value.
So there you have it. Analysts tend to develop their opinions based on both the information available as well as their ability to glean the additional details on what creates business value. The conclusion is only as good as the credibility of the business appraiser.