The logic of company valuation is that "value determines price". The valuation methods of listed companies are usually categorized into two types: one is relative valuation methods (such as price-earnings ratio valuation method, price-net ratio valuation method, EV/EBITDA valuation method, etc.); the other is absolute valuation methods (such as discounted dividend model valuation, discounted free cash flow model valuation, etc.).

1) Relative valuation method

Relative valuation method is simple and easy to understand, and is the most widely used valuation method by investors. In the relative valuation method, the commonly used indicators are price/earnings ratio (P/E), price/net worth ratio (PB), EV/EBITDA multiples, etc., and their formulas are as follows:

Price/earnings ratio=price per share/earnings per share

Price/net worth ratio=price per share/net worth per share

EV/EBITDA=Enterprise value/Earnings before interest, taxes, depreciation and amortization (EBITDA) Earnings

(where: enterprise value is the sum of the total market value of the company's stock and the value of interest-bearing debt less cash and short-term investments)

The multiples derived from the use of relative valuation methods are used to compare the relative valuation levels between different industries and between companies within an industry; the values of the indicators for companies in different industries do not allow for direct comparisons, and the differences can be significant. The relative valuation method reflects this. Through the comparison of different companies within the industry, it is possible to identify companies that are relatively undervalued in the market. However, this is not absolute, such as the market to give the company a higher price-earnings ratio indicates that the market is more optimistic about the company's growth prospects, and is willing to give the advantageous companies in the industry a certain premium. Therefore, when using relative valuation indicators to analyze the value of the company, it is necessary to combine the macro-economy, industry development and the company's fundamentals, specific company-specific analysis. Compared with the absolute valuation method, the relative valuation method has the advantage of being relatively simple and easy to be grasped by ordinary investors, and it also reveals the market's evaluation of the company's value. However, in the event of large market fluctuations, the price-earnings ratio and the price-net ratio are also subject to large variations, which may be misleading in the assessment of a company's value.

2)Absolute Valuation Methods

The discounted dividend model and the discounted free cash flow model use the capitalization of income pricing method, by predicting the company's future dividends or future free cash flow, and then discounting it to get the intrinsic value of the company's stock. The most general form of the discounted dividend model is as follows:

Where V represents the intrinsic value of the stock, D1 represents the dividends available at the end of the first year, D2 represents the dividends available at the end of the second year, and so on ......, and k represents the return on capital/discount rate.

If Dt is defined to represent free cash flow, the discounted dividend model becomes a discounted free cash flow model. Free cash flow is the amount of money left over after a company's after-tax operating cash flow after deducting the amount of additional investment made during the year.

Compared with the relative valuation method, the absolute valuation method has the advantage of being able to reveal the intrinsic value of a company's stock more accurately, but it is more difficult to choose the right parameters. Deviations in the forecast of future dividends and cash flows, and deviations in the selection of the discount rate may affect the accuracy of the valuation.

So how does a value investor solve the valuation puzzle?

The main methods of company valuation can be summarized into three categories:

Discounted Cash Flow (DCF)

Discounting a company's future cash flows to a specific point in time in order to determine the intrinsic value of the company

Comparable Companies Analysis

Comparable Companies Analysis

Discounting a company's future cash flows to a specific point in time in order to determine the intrinsic value of the company. Companies Analysis)

Extrapolating the value of a company using various valuation multiples of similar companies

Comparable Transactions Analysis

Extrapolating the value of a company using various valuation multiples of similar transactions

There are a number of quantitative methods for company valuation, but the operation process takes into account a number of qualitative factors, and traditional financial analysis only provides a valuation reference and determines the possible range of company valuation. According to the market and the company's situation, the following valuation methods are widely used:

1. Comparable company method

First of all, it is necessary to select the listed companies in the same industry with the non-listed companies that are comparable or can be referred to the share price of similar companies and financial data as a basis for calculating the main financial ratios, and then use these ratios as a market price multiplier to deduce the value of the target company, for example, P/E (price/earnings ratio, price/capitalization ratio, price/capitalization ratio, price/capitalization ratio). E (price/earnings ratio, price/profit), P/S method (price/sales).

In the domestic venture capital (VC) market, the P/E method is a relatively common valuation method. There are two types of P/E ratios we usually refer to for listed companies:

Historical P/E (Trailing P/E) - i.e., current market capitalization/company's profit for the previous financial year (or profit for the previous 12 months).

Forward P/E - i.e. current market capitalization/company's profit for the current financial year (or profit for the next 12 months).

Investors are investing in the future of a company, and they use the P/E method of valuation as follows:

Company value=Forward P/E ratio x company's profit for the next 12 months

The company's profit for the next 12 months can be estimated from the company's financial forecasts, and the biggest problem in valuation is how to determine the Forward P/E ratio. Generally speaking, the projected P/E ratio is a discount to the historical P/E ratio, for example, NASDAQ average historical P/E ratio for a particular industry is 40, then the projected P/E ratio is about 30, for the same industry, the same size of the unlisted companies, reference to the projected P/E ratio needs to be further discounted, 15-20 or so, for the same industry and the smaller start-ups, reference to the projected P/E ratio needs to be further discounted, it becomes 7-20 or so. Discount, it becomes 7-10. This is also the mainstream domestic foreign VC investment is the approximate P/E multiple of the enterprise valuation. For example, if a company predicts that the next year's profit after the SME financing is 1 million U.S. dollars, the company's valuation is roughly 7-10 million U.S. dollars, if the investor invests 2 million U.S. dollars, the company's share is about 20% -35%.

For companies with revenues but no profits, P/E is meaningless, for example, many startups can not achieve positive projected profits for many years, then you can use the P/S method of valuation, roughly the same method as the P/E method.

2. Comparable Transaction Method

Select companies in the same industry as the startup, which have been invested in or merged and acquired during a suitable period before the valuation, and based on the pricing basis of SME financing or M&A transactions as a reference, obtain useful financial or non-financial data from them, and find out some corresponding SME financing price multipliers, accordingly evaluate the target company.

For example, if Company A has just obtained SME financing, and Company B is in the same business area as Company A, and twice as big as Company A in terms of scale of operation (e.g., revenues), then the investor's valuation of Company B should be about double that of Company A. In the case of, for example, Focus Media in the merger and acquisition of Framework Media and Gathering Media respectively, on the one hand, the market parameters of Focus are used as a basis, and on the other hand, the valuation of Framework can be used as a basis for the valuation of Gathering.

The comparable transaction method does not analyze the market value, but only counts the average premium level of the SME financing M&A price of similar companies, and then calculates the value of the target company with this premium level.

3. Discounted cash flow

This is a more mature valuation method, through the prediction of the company's future free cash flow, the cost of capital, discounting the company's future free cash flow, the company's value that is the present value of future cash flow. The formula is as follows: (where CFn: projected free cash flow per year; r: discount rate or cost of capital)

The discount rate is the most effective way to deal with the risk of forecasting, as startups have a high degree of uncertainty in their projected cash flows, and their discount rates are much higher than those of mature companies. The cost of capital for startups seeking seed funding is perhaps in the range of 50%-100%, for early stage startups it is 40%-60%, and for late stage startups it is 30%-50%. By contrast, companies with more established operating records have a cost of capital of between 10-25 percent.

This approach is more applicable to more mature, late-stage private or public companies, such as Carlyle's acquisition of XCMG, which used this valuation method.

4. Asset-based approach

The asset-based approach assumes that a prudent investor would not pay more than the cost of acquiring assets of the same utility as the target company. For example, CNOOC bid for Unocal and valued the company based on its oil reserves.

This method gives the most realistic figures, usually based on the money spent to grow the company. Its shortcomings lie in the assumption that the value is equal to the money used, and investors do not take into account all the intangible values associated with the company's operations. In addition, the asset approach does not take into account the value of future projected economic returns. Therefore, the asset approach values the company and results in the lowest possible value.