Valuing Businesses Using Regression Analysis

CHAPTER 2The Solution

An appraiser or anyone reading an appraisal is only going to see a valuation for one company. Thus, one will not be aware that the values for an underperforming or over‐performing subject are potentially way off the mark when using the median to calculate multipliers. Why are the values for companies that are at the opposite ends of the cash flow spectrum so divergent? Answer: Regardless of how profitable the subject company was, it was accorded the same median multipliers gleaned from the sample. In other words, median and quartiles are one‐dimensional.

The solution is to add another dimension to the analysis.

IRS Revenue Ruling 59‐60 instructs business appraisers to give considerable weighting to a company's profitability when determining its value.¹ As such we observe the subject's cash flow growth over the previous several years and identify all the drivers that created that growth. We also look at the subject's local market and how it will affect its operations and consider the prospects for its continued growth in the future. We then compared the subject's balance sheet and P&L ratios to a database of thousands of similar companies to determine the subject's relative strength compared to its peer group. The question is, then, once we have determined that our subject is better than its peer group, what is the market willing to pay for that distinction?

When trying to make a direct comparison of the subject to companies that have recently sold, the ...