Valuation of Companies in UAE with many ways including evaluation by the net book value of the company, the adjusted book value, the replacement value, the discounted cash flows, the evaluation by profit multiplier, the net market value of the company, and the remaining value of the company.
Truth Economic Consultancy renders services of valuation of companies in UAE and economic institutions and issuing accredited certificates of the evaluation results either technically or financially. We use our accumulated experiences in this domain. Hereunder is an overview of the companies’ valuation:
There are many evaluation methods used as a basis for evaluating companies and then shares pricing. Even though such methods have a recognized international basis, we cannot take for granted such methods are perfect for achieving success in the evaluation of a company and its shares, whether such evaluation is made for a company that has outstanding shares, a new placement, or completing the requirements of privatization of a state-owned institution.
Not all the methods adopted internationally can be fit locally; this fact is rarely considered, especially that the problem of estimating the fair value of assets and companies has become one of the most debatable issues in most of Arab countries.
It is seen by many as a type of accusation of wasting the assets value. Upon tackling the subject, corruption appears in the picture or accusations of exaggeration in augmentation and evaluation are hurled. Accordingly, we try to discuss this complicated subject in brief, in such a manner that lifts the clouds that envelop this matter.. In general, there are many internationally recognized ways for evaluation including:
- Evaluation method by the company’s net book value.
- Evaluation method by the adjusted book value.
- Evaluation method by the replacement value.
- Evaluation method by the discounted cash flows form (the commonly used).
- Evaluation method by the profit multiplier.
- Evaluation method by the company’s net market value.
- Evaluation method by the company’s remaining value.
1- Evaluation method by the company’s net book value:
It means the net historic wealth of owners, or in the accounting terms it is the net value of the rights of stockholders in assets after deducting any obligations, debts, or liabilities payable on the company – to third parties – out of the company’s total assets at the time of evaluation.
That method is based on the historic cost of assets and disregards the real and actual value of those assets; as it does not take into consideration factors like price inflation and changes and pays no attention to the company’s economic potentials of growth in future.
2- Evaluation method by the adjusted book value:
Through this method, the company’s assets value is re-calculated by using scales known for this purpose to amend the book value of the asset, taking into account the ratio of the historic annual inflation in the prices of that company’s asset at the date of purchasing it until the evaluation date. The net value of stockholders’ rights is calculated on this basis. This method’s defect is that it does not consider the technical obsolescence of machines, especially that most business-sector companies have production and technology obsolescence. Consequently, the results are non-objective. Furthermore, this method does not take into consideration the company’s future growth potentials.
3- Evaluation method by the replacement value:
The concept of this method is based on estimating the cost of establishing a company now with the same properties of the company subject to evaluation. The assumption, on which this method is based, is non-objective, especially in light of the properties of public-sector companies, the most of which were under certain circumstances during their formation and ownership development. Hence, it is difficult to presume re-establishing companies with the same properties. This method also disregards the company’s growth potentials. A serious mistake may happen in estimating the current establishment cost since the estimation is made by men.
It is noticed that the previous three methods have general properties, the most clear of which is that they are based on overlooking the opportunities of profitability and future growth of the company and assuming that the company’s buyer purchases it for its historic status only whether or not the status quo of the company, the inflation, and price changes are taken into consideration.
In addition, these methods provide exaggerated values that do not match with profitability potentials of some companies such as real-estate companies. They may provide less values for other companies that are inconsistent with high profitability potentials of those companies, which practice service business such as banks, due to their small assets.
4- Evaluation method by the discounted cash flows form (the commonly used):
This method is based on making assumptions, through which the company’s financial standing can be forecasted until the end of a specific term- which may go beyond 10 years – linked to the productive life of the company’s assets. This is associated with forecasting the company’s work results, its financial standing, and cash status, then deducting the expected net cash flows of the company by discount factor to be estimated considering the borrowing interest rates- finance sources cost- and business risks. The previous method is the most popular and most widely used for estimating companies. It is also the most widely accepted in evaluating companies that circulate their shares in the stock exchange. The companies are evaluated by the expected growth potentials, provided that this growth is measured by the company’s cash power, which is deemed in the financial terms the foundation of the company’s growth. Even though this method is important, its problems lie in having a wide space for assumption and estimation; this undoubtedly affects its objectivity, especially when the estimation period is long.
5- Evaluation method by the profit multiplier:
According to this method, the share value is estimated by reliance on calculating the share return expected for one year and multiplied by the applicable profitability multiplier of the same companies trading in the stock exchange and having the same business. This method depends on the return expected for one year and neglects the growth potentials of the company in the coming years. It is based on the current market circumstances, which may not efficiently reflect the prices, and assumes the market efficiency, i.e. the trading companies represent their production sector.
The share return expected for one year = The share quota in cash dividends + reserves + the profitability multiplier earnings for an outstanding share = the share market price divided by the share dividend or the reciprocal of investment rate.
6- Evaluation method by the company’s net market value:
It is similar to the replacement method previously discussed. Yet, it deals with the company with the purpose of liquidation, not re-formation; i.e. it disregards items of the value components such as the costs of a license, construction, feasibility, which should be considered in the replacement value. This method comes under the same censures that face historic and current evaluation methods.
7- Evaluation method by the company’s remaining value:
This method is similar to cash flows deduction model. Yet, it suffices with a limited number of years that is not associated with the productive capacities of assets, provided that the remaining value of the company shall be calculated in the last year of the evaluation term. More than one method are used to evaluate that remaining value of the company. In addition to the previous methods, there is more than one way; however, the said seven methods are the most popular and commonly used in the domain of shares evaluation.
Which evaluation method will be selected by the stock exchange investor?
Despite the diversity of the evaluation methods, through analyzing the concepts of those methods, we notice the following:
Some evaluation methods rely on how the company is currently viewed, whether such view is based on historic or current basis without observing the growth potentials (book value, adjusted book value, replacement value, and market value).
Other methods consider the company’s growth potentials, in which the potentials and revenues value of the current assets such as (the expected flows, profits, and dividends ) are implicitly considered.
All methods “except for the book value and the adjusted book value” are based on making assumptions that involve human’s intervention and the extent of availability and soundness of information in an influential way. This influence is expanded with the second group of the evaluation methods which need imagination. Making forecast assumptions entails high risks that expectations may not materialize.
It is believed that investors dealing in the companies’ shares fall under two types:
I. It is the investor who seeks to control and take over the company. Hence, he takes into consideration the existing and historic status of the company mainly on the assumption of being vested with the powers of developing the company and changing the structure of its assets in such a way affecting the growth potentials. Accordingly, the investor pays no attention to the growth potential of the current assets. Hence, the investor sees the first group methods more reflective of the economic value of the institution.
II. It is the investor who does not seek to take over. The investment decision is primarily based on the company’s capacities of expanding the growth potentials in such a way influencing its cash position and profits- the outputs of its businesses in general- and consequently the increment in cash dividends of the company, and this means dramatic increase in the return on investment in the company.
Finally.. the concept of estimation and determination of fair value is extremely relative and complicated. Accordingly, it is very difficult to arrive at a conclusion whereby an accusation of detriment is hurled or a reform is praised.In witness whereof, in order to seek a fair judgment and objective thinking, we have first to ask about the basis and assumptions of evaluation if we really want to safeguard our sold assets.