One of the fundamental services investment banks offer to clients is to provide a valuation of their business (usually in the context of an M&A transaction or when the company raises equity). A simple analogy for understanding how a business is valued is that of how one might consider a house to be valued.
There are two broad methods by which the value of a house may be determined. The first is a market-based method, which could involve comparing the value of properties with similar characteristics (such as size and location) or the price paid for similar properties in the past. The second is an intrinsic valuation method, for example valuing a house based on its ability to generate rental income.
In the context of valuing a business, the same principles apply. A market-based valuation of a public listed company could involve an investor taking into account the price paid for other similar businesses in the market. An intrinsic valuation would focus more on the cash flows that the company has generated (or could potentially generate), based upon the company’s financials.
By Jake Schogger - City Career Series