Beauty (Value) is in the eye of beholder : Is DBS really worth $16.06 ?

《每个人心中都有一把尺》

We often look at things by setting our own standards and base on our own yardsticks and the same applies to the company’s valuation. Everyone may have their biases when comes to valuation and value is more than just a number.

All Valuation is Biased !!

According to Aswath Damodaran ( a Professor of Finance at NYU’s Stern School of Business ) in his book “ The Little Book of Valuation “ try to warn us that “all valuation is subjected to biased “.

“ You almost never start valuing a company or stock with a blank slate. All too often, you view on a company or stock are formed before you start inputting the numbers into the model and metrics that you use and not surprisingly, your conclusions tend to reflect your biases. The bias in the process starts with the companies you choose to value. 

These choice are not random, it may be that you have read something in the press ( good or bad ) about the company or heard from a talking head that a particular company was under or overvalued. It continues when you collect the information you need to value the company. The annual report and other financial statements include not only the accounting numbers but also management discussion of performance, often putting the best possible spin on the number. “ explained Prof Aswath Damodaran in his book.

There is myriad of methods in valuation when you search in google by keying in “ how to value a company”, you will find thousands of message in explaining different methods of valuing a firm.

Valuation Methods

By WikiInvest.com

If I buy a company, I buy its stock (equity) and assume its debt (bonds and loans). Buying a company's equity means that I actually gain ownership of the company - if I buy 50% of a company's equity, I own 50% of the company. Assuming a company's debt means that I promise to pay the company's lenders the amount owed by the previous owner.

The value of debt is easy to calculate: the market value of debt is equal to the book value of debt. (If in the books it says that a company owes its bondholders $1 million, that's how much that debt is worth in the market.) Figuring out the market value of equity is trickier, and that's where valuation techniques come into play.

The four most commonly used techniques are:

§  Discounted cash flow (DCF) analysis

§  Comparable transactions method

§  Multiples method

§  Market valuation

Discounted Cash Flow Analysis

DCF analysis is the most thorough way to value a company. There are two ways to value a company using the DCF approach: the Adjusted Present Value (APV) method and the Weighted Average Cost of Capital (WACC) Method. Both methods require the calculation of the free cash flows (FCF) of a company and the net present value (NPV) of these FCFs.

Comparable Transaction Method

With this technique of valuing a company for a merger or acquisition, you look at transactions that have taken place in the industry that is similar to the transaction under consideration. With the comparable transactions method, you are looking for a key valuation parameter.

That is, are the companies in those transactions being valued as a multiple of EBIT, EBITDA, revenue, or some other parameter? If you figure out what the key valuation parameter is, you can examine at what multiples of those parameters the companies are being valued in a series of transactions. You can then value the company similarly.

Multiples method

Quite often, there is not enough information to be able to determine the valuation using the comparable transactions method. In these cases, you can value a company based on market valuation multiples. Examples of these valuation multiples include price/earnings multiples (also known as P/E ratios, this method, which compares a company's market capitalization to its annual income, is the most commonly used multiple) EBITDA multiples and others. When using this method, you look at what multiples are used for other companies in the industry.

Market Valuation

The origin of the market approach of business valuation is established in the economic rationale of competition. It states that in the case of a free market, the demand and supply effects direct the value of business properties to a particular balance. The purchasers are not ready to pay higher amounts for the business and the vendors are not ready to receive any amount, which is lower in comparison to the value of a corresponding commercial entity.

The market approach of business valuation ascertains the value of a firm by performing a comparison between the firms concerned with organizations in a similar location, of equal volume or operating in a similar sector. It has a large number of resemblances with the comparable sales technique, which is generally utilized in case of real estate estimation. The market value of shares of companies that are traded publicly and are involved in identical commercial activities may be a logical signal of the value of the commercial operation. In this case, the company shares are bought and sold in an open and free market. This process allows the purposeful comparison of the market value of shares.

One needs to take note that a small change in criteria or parameter in any valuation methods will have a big impact on the result, e.g a small change in “ r ( cost of capital ) or g ( growth rate ) in DDM ( Dividend Discounted Model) will get much different result in final valuation.

Is DBS really worth $16.06?

6 stock analysts from different brokerage house will give you a very much different valuation of DBS, ranging from $14.55 - $18.99 ( a different of $4.43 ), base on their criteria and yardsticks.

The difference in value is about 27% ( +/- ) swing from the current price. You may wonder why there is such huge different if everyone is using and accessing to same accounting data and info of the company.

image credit to sginvestors.io

Narrative and Number

I really look forward to this new book by Prof Aswath Damodaran which I have pre-order :

“Through a range of case studies, Narrative and Numbers describes how storytellers can better incorporate and narrate numbers and how number-crunchers can calculate more imaginative models that withstand scrutiny. 

Damodaran considers Uber's debut and how narrative is key to understanding different valuations. He investigates why Twitter and Facebook were valued in the billions of dollars at their public offerings, and why one (Twitter) has stagnated while the other (Facebook) has grown. 

Damodaran also looks at more established business models such as Apple and Amazon to demonstrate how a company's history can both enrich and constrain it's narrative. 

And through Vale, a global Brazil-based mining company, he shows the influence of external narrative, and how a country, commodity, and currency can shape a company's story. Narrative and Numbers reveals the benefits, challenges, and pitfalls of weaving narratives around numbers and how one can best test a story's plausibility.”

In our local financial blogosphere, we can find a few very good bloggers who can really explain the figures behind the financial statement instead of  punching in a few parameters in determine and getting the result of the company’s valuation.

Allow me to show you some link on this :

  Article from Investmentmoats.com on how to analyse a REIT

Company analysis from SG Thumbtack Investor

Another good blogs on company analysis from “ B “: A Path to Forever Financial Freedom

There are many different ways to value stocks. The key is to take each approach into account while formulating an overall opinion of the stock. If the valuation of a company is lower or higher than other similar stocks, then the next step would be to determine the reasons.

Don’t just simply take the figure given by analyst for granted and look and the “narrative “ of the number.

Cheers !

STE

Quote Of The Day :

“Stock valuation is not a prediction but a convention, which serves to facilitate investment and ensure that stocks are liquid, despite being underpinned by an illiquid business and its illiquid investments, such as factories.” By John Maynard Keynes