Introduction to Corporate Valuation

What is the role of financial forecasts in corporate valuation?

Valuations are always looking forward, however we also need to assess past results in order to understand the following:

• How the firm compares to its peers
• Progress of the firm’s financial results
• How will past decisions affect the future

Although we may be able to extrapolate historic results into the future, we need to keep in mind that due to the ever changing economic conditions faced by corporates, including volatile inflation and input prices, geo-political risks and weakening demand, forecasting is very difficult. This can lead to volatile valuations.

What are the other factors that need to be considered?

• Overall level of and outlook for the stock market - A rising market will generally lead to an increase in most valuations
• Overall liquidity outlook - As liquidity is withdrawn via quantitative tightening and rising interest rates, corporate valuations tend to fall
• Risk appetite of investors – risk aversion tends to lead to falling equity values, as investors switch to bonds and cash
• Outlook for key economic variables - This has a significant impact on equity valuations. Some variables are GDP growth, disposable incomes, the savings rate, interest rates and quantitative easing or tightening, inflation and currencies
• Debt market conditions - When borrowing is cheap, easily available and with limited conditions, this helps drive a rise in equity valuations
• Dividends and buybacks -  If a firm announces higher dividend growth and/or share buybacks, this is normally positive for equity valuations. However, downward revisions of these will have a negative impact

What are the factors that can cause immediate and sharp changes in valuation?

• Inclusion or exclusion in a major index - Inclusion of a firm into an index fund means the fund must buy shares of the firm and this is a positive for valuation
• IPO lock up period - When this period is due to end, if founding shareholders sell their shares, it usually puts downward pressure on the price
• Company announcements - These have a material impact on valuations, either up or down. Important announcements include those regarding M&A transactions, strategy changes and management changes and financial forecasts