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Company Valuation: Methods & Case Study

Company Valuation: Methods & Case Study

Determining a company’s financial outlook is like solving a major puzzle. There are many pieces, but some are the real game-changers. In this blog, we’re going to explore these critical methods, and we’ll use a famous company in our case study to see it in action.

Table of Contents:

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What is Company Valuation?

What is Company Valuation?

The valuation of a company involves assessing its economic worth, considering factors like financial performance, future growth potential, and the value of assets and liabilities. This process serves various purposes, including facilitating the sale or purchase of a company, raising capital, or determining the equitable value of its shares.

Company valuation is a complex and ever-evolving process, with no single approach that is best for all businesses. The ideal valuation approach for a particular company depends on factors such as its industry, developmental stage, and financial position. It is important to understand that company valuation is an estimation, and the actual value of a company may evolve over time.

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Methods to Calculate Company Valuation

Understanding the methods to calculate company valuation is vital for investors, analysts, and business leaders alike. It provides a structured approach to assessing a company’s financial health and growth potential. This understanding gives decision-makers the confidence to make smart choices regarding investments, mergers, acquisitions, and overall financial strategies.

These are the approaches for determining company valuation:

Market Capitalization:

Market capitalization, or market cap, is the total value of a company’s outstanding shares, calculated by multiplying the current share price by the number of shares outstanding. Market capitalization reflects the collective judgment of investors about the company’s worth at a given point in time. Let’s say a company in India has 2 million outstanding shares, and the current market price per share is ₹200. To calculate the market capitalization, you would follow this formula:

Market Capitalization = ₹200 (Current Market Price per Share) × 2,000,000 (Total Outstanding Shares) = ₹400,000,000.

In this example, the company’s market value is ₹400 crore. This valuation method is particularly relevant for publicly traded companies, where share prices are determined by market dynamics and investor sentiment.

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Asset-Based:

Asset-based valuation is a method employed to ascertain a company’s value by evaluating its net assets. This involves deducting total liabilities from total assets to arrive at the net asset value. For instance, if a company possesses total assets valued at ₹10,000,000 and total liabilities of ₹4,000,000, the asset-based valuation would be:

Asset-Based = ₹10,000,000 (Total Assets) - ₹4,000,000 (Total Liabilities) = ₹6,000,000

This method proves especially beneficial for businesses with substantial tangible assets like real estate or equipment, as it offers a straightforward assessment of the company’s net worth in terms of its physical resources.

Enterprise Value:

Enterprise value (EV) is a comprehensive measure utilized to assess a company’s overall value, encompassing not only its market capitalization but also its debt, cash, and investments. This measure provides a more inclusive evaluation of a company’s worth by considering its complete capital structure. For example, if a company has a market capitalization of ₹500 crores, total debt of ₹100 crores, and cash and cash equivalents of ₹50 crores, the Enterprise Value would be:

EV = ₹500 Crores (Market Capitalization) + ₹100 Crores (Total Debt) - ₹50 Crores (Cash & Cash Equivalents) = ₹550 Crores

Taking into account both debt and cash, the company’s enterprise value stands at ₹550 crores. This figure is important for potential buyers or investors as it offers a more accurate measure of the company’s true worth compared to just market capitalization.

Discounted Cash Flow (DCF): 

Discounted cash flow (DCF) is a valuation method that calculates the present value of a company’s future cash flows, taking into account the time value of money. It is based on the principle that money received in the future is worth less than money received today because it can be invested and earn interest. DCF analysis considers a company’s projected cash inflows and outflows over a specified period, using a discount rate that reflects the company’s risk profile.

Let’s understand with an example: if a company is expected to generate  ₹5 crore in cash flows each year for the next five years, and the discount rate is 10%. The DCF valuation would be calculated as follows:

DCF = CF1(1+r1) + CF2(1+r2) + CF3(1+r3) + . . . .  + CFn(1+rn)
 DCF =  ₹5,000,000(1+0.101) +₹5,000,000(1+0.102) + ₹5,000,000(1+0.103) + ₹5,000,000(1+0.104) + ₹5,000,000(1+0.105)
DCF = ₹4,545,455 + ₹4,132,231 + ₹3,756,573 + ₹3,414,157 + ₹3,100,142 = ₹19,938,558

Using the DCF approach, the present value of the anticipated cash flows amounts to approximately ₹19.94 crores, indicating the estimated value of the company.

EBITDA:

EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, serves as a financial measure designed to evaluate a company’s operational performance. By omitting non-operational costs, it provides a more transparent assessment of a company’s profitability prior to considering financial strategies, accounting procedures, and tax-related consequences. For instance, when a company reports a net income of ₹50,00,000, and incurs ₹10,00,000 in interest expenses, ₹12,00,000 in taxes, ₹8,00,000 in depreciation, and ₹3,00,000 in amortization, the EBITDA computation would appear as follows:

EBITDA = ₹50,00,000 (Net Income) + ₹10,00,000 (Interest) + ₹12,00,000 (Taxes) + ₹8,00,000 (Depreciation) + ₹3,00,000 (Amortization) = ₹83,00,000.

In this specific scenario, the company’s EBITDA is ₹83,00,000, indicating its operational performance prior to factoring in interest, taxes, depreciation, and amortization expenses. This measure proves invaluable when it comes to understanding the fundamental profitability of the company.

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Case Study of Company Valuation: Methods and Examples

Case Study of Company Valuation: Methods and Examples

About the Company:

Established in 2010 by Nikhil Kamath and Nitin Kamath, Zerodha is a prominent Indian financial services company specializing in retail and institutional broking services within the equity, currency, and commodity markets. Remarkably, Zerodha is a bootstrapped company, meaning it’s self-funded and has relied on internal resources for growth. With over 5 million active clients and a market share exceeding 15%, it stands as India’s largest retail stockbroker.

Valuation:

Founded Year:2010
Duration in Market:13 years
Annual Growth:44%
Total Assets:₹1,822.13 crores
Percentage of Equity with Founder:100%
Total Annual Revenue:₹5,045.54 crores
Total Annual Expenses:₹3,374.67 crores
EBITDA:₹1,670.87 crores
Price-to-Earnings Ratio:43.54
Return on Equity (ROE):93.87%
Return on Capital Employed (ROCE):91.56%
Earnings Per Share (EPS):₹11.27
Return on Net-Worth (RoNW):91.56%
CAGR:40%
Total Valuation:₹147,500 crores

Over the course of 13 years, Zerodha has emerged as a major player in the Indian stock broking industry, experiencing remarkable annual growth of 44%. This impressive expansion underscores its ability to capture a larger market share and attract a growing customer base, reflecting the demand for its services.

Additionally, Zerodha’s robust financial position is evident in its total assets, which amount to ₹1,822.13 crore. Notably, it is a bootstrapped company, and its founder, Nithin Kamath, retains 100% equity ownership, demonstrating a strong commitment to the business.

Zerodha’s financial performance continues to shine with a total annual revenue of ₹5,045.54 crores, driven primarily by brokerage fees and other revenue streams. Meanwhile, the company manages its operations efficiently, with annual expenses of ₹3,374.67 crore. The Earnings Before Interest, Depreciation, Tax, and Amortization (EBITDA) stand at ₹1,670.87 crores, highlighting its core operational performance.

Zerodha’s Price-to-Earnings ratio (P/E ratio) of 43.54 suggests investor confidence in its future growth potential. Strong metrics like Return on Equity (ROE) at 93.87%, Return on Capital Employed (ROCE) at 91.56%, and Earnings Per Share (EPS) of ₹11.27 further emphasize its profitability. The Compound Annual Growth Rate (CAGR) of 40% underscores Zerodha’s sustained and steady revenue growth, ultimately contributing to a total valuation of ₹147,500 crores, reflecting investors’ willingness to invest in its future prospects.

Conclusion of this Case Study:

Zerodha’s rapid growth in the Indian stockbroking sector is a remarkable success story to learn from. It is powered by its exceptional annual growth, strong financial foundation, and commitment to its self-sustained model.

The company’s impressive financial indicators, resilient operational performance, and high investor trust underscore its position as a prominent player. Zerodha’s devotion to innovation, combined with its commitment to affordability and accessibility, has had a significant impact on the industry while pushing the company toward a promising future.

Conclusion

Company valuation is a nuanced process, blending financial expertise with strategic insight. As businesses evolve, mastering valuation techniques becomes paramount. Whether for investment decisions, mergers, or internal assessments, understanding a company’s true worth empowers informed choices. Plus, it opens up opportunities for smart moves in the future. The dynamic interplay of assets, revenue, and financial intricacies shapes a comprehensive view of its economic standing.

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