When Theory Meets Reality - 1/2
What the Textbooks Miss in Valuation Practice (Part 1/2)
Have you ever sat down with someone who built a billion-dollar empire from scratch and realised they couldn’t name a single valuation method? I did. It was a family business—no fancy tech, no groundbreaking innovation—just savvy operators in a tough industry who built massive moats using mergers and acquisitions (M&A).
And here’s the kicker: Not one of them had a college degree. Forget MBAs—they probably thought "DCF" stood for "Don't Care, Friend." Yet, they managed to achieve something most of the smartest folks from top business schools only dream of—adding a third comma to their bank accounts.
I’ve worked with incredibly sharp minds, dissecting valuation methodologies with managing directors from every big investment bank you could name. They had successful careers, no doubt. But billionaires? Not quite.
The magic formula these self-made billionaires used wasn’t some complex valuation model. They didn’t calculate terminal growth rates or lose sleep over internal rates of return (IRR). Instead, they had an uncanny ability to buy assets and businesses at prices so low, they simply couldn’t lose.
The Art of Patience and Simplicity
Their strategy was beautifully straightforward: find good assets being run poorly, and wait. Sometimes for years, even decades. When the time was right, they’d swoop in, buying at or near book value. They’d improve profitability, integrate the asset into their core operation, and voilà—instant value creation. They bought at book values and held or sold at an earnings multiple.
They understood that valuation isn’t a precise science. It's more like art. You can analyze all you want, but at the end of the day, if you try hard enough, you can justify any price within a range. It’s a minefield of cognitive biases and conflicts of interest—something I’m sure you’ve seen before.
Enterprise Value vs. Equity Value: Let's Break It Down
Before we dive into methodologies, let’s clear up two critical terms: Enterprise Value and Equity Value.
Enterprise Value is the total value of a company's assets, excluding its debt and cash. It’s like looking at a car's price without considering how much gas is in the tank or if it has a loan on it.
Equity Value is what you'd actually pay to buy the business. You start with the enterprise value, add cash, subtract debt, and adjust for working capital.
Why does this matter? Because acquisition offers are typically made on an enterprise value basis. The tricky part is bridging enterprise value to equity value, which is why valuation conversations often start with enterprise value—it keeps things clean and comparable.
Valuation: The "Science" That Often Misses the Art
Ever heard the saying, “A business is worth whatever someone is willing to pay for it”? Yeah, I hate that cliché. It’s not just unhelpful; it’s misleading. It ignores the massive information gap between buyers and sellers. It’s like saying, "A house is worth whatever the highest bidder offers," without mentioning if the roof leaks or if it’s haunted.
For us finance nerds, there are three main schools of valuation theory:
Discounted Cash Flow (DCF) – The purist’s method. It calculates the present value of future cash flows. It’s technically perfect but relies on forecasts, which are, let’s face it, often just educated guesses.
Multiples of a Metric – The practical approach. You apply a multiple (derived from similar deals) to a business metric, usually EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). It's less precise but more real-world.
Asset-Based Valuation – Common in distressed sales, this method values each asset separately. It’s like selling a car for its parts instead of as a whole.
In part 2, I will share my experience on a textbook method that seems to fall short.