The Gap between Theory and Practice of Firm Valuation: Survey of European Valuation Experts
30 Pages Posted: 5 Apr 2014
Date Written: March 27, 2014
We survey 356 valuation experts across 10 European countries with CFA or equivalent designation to gain some insights into their valuation practices. We find that while most experts use both Discounted Cash Flow (DCF) and Relative Valuation (RV) models, their assumptions and estimation methods for almost all inputs in models vary widely. For example, 65% (35%) use less (more) than three-year historical data for beta estimation; 58% (42%) use ex-post (ex-ante) market risk premium with subjective size or liquidity risk adjustments; 40% (29%) use market (book) value weights for WACC, and about 50% estimate Terminal Value by discounting a normative cash flow until infinity whereas others employ a decreasing cash flow or a multiple approach. In RV application, Firm Value/EBITDA is the most popular multiple used by 83% of experts, followed by PE (68%), Price-to-Book (45%), Firm Value/EBIT (45%), and Firm Value/Sales (45%). About half of respondents have also modified their discount rate, country risk, or liquidity risk estimation in the wake of the 2008 financial crisis. These wide disparities indicate that two valuation experts could arrive at substantially different valuation estimates, despite using the same model. While most disparities arise because theory provides little guidance on estimation, some are also a result of practitioners not following theoretical guidelines, such as using book value weights or not adjusting historical betas to make them forward looking. Our findings suggest that a serious debate is needed between academics and practitioners to make the valuation framework more “practical”.
Keywords: Valuation methods, Firm value, Asset value, Discounted cash flow, Terminal value, CAPM, cost of capital, Relative valuation, Financial crisis, European countries.
JEL Classification: G12, G31, G32
Suggested Citation: Suggested Citation