WWII 020: Sum of The Parts Valuation, Danny DeVito,Gregory Peck, Other People's Money, Dangers with ETFs
In this episode, I shine the light on the Sum of the Parts Valuation which is a type of valuation methodology that falls under the Assets Approach to valuation. As part of this episode, I play a short clip from the movie "Other People's Money" starring Danny DeVito and Gregory Peck. Give it a listen!
Valuation: Sum of the Parts
· There are several ways to figure out how much a company is worth
o Income approach
o Market Approach, also called Private Market Value – willing buyer and willing seller
o Asset Approach: Sum of the Parts –or replacement cost approach, or liquidation value.
· Different approaches are necessary for different types of businesses. For example, attempting an income approach valuation on a company with no earnings but lots of assets would not result in a reliable valuation.
· Sum of the Parts Valuation starts with the balance sheet. The balance sheet will show you assets and liabilities and the Asset approach requires you to value each asset at its market value, and each liability at what it would ultimately cost the business to pay it off.
· Different kinds of assets need to be valued different ways, and here are some examples:
o Land and Buildings should be valued at market value, not historical cost
o Equipment should be valued at salvage, or replacement cost
o Working capital which consists of cash, receivables, inventory, and accounts payable is usually fairly reliable, although in some cases, more receivables may be uncollectible than the balance sheet suggests
o In other cases inventory could be more obsolete than the balance sheet suggests.
o Wholly owned operating businesses are usually valued on the income approach.
o Watch for hidden assets such as unconsolidated equity in affiliates or joint ventures.
o Hidden liabilities such as pension obligations, joint venture funding requirements, volume commitments, leases etc.
· Tease apart the business into separate components, value each component with the proper valuation type
· Put them all together to get an idea of what the business is worth overall, and then divide by the number of shares outstanding to get the value per share.
· You can see this method requires you to be well versed in the different ways of valuing a business.
“For investing to be reliably successful, an accurate estimate of intrinsic value is the indispensable starting point. Without it, any hope for consistent success as an investor is just that: hope.”
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