The Nature of Value by Nick Gogerty

Author:Nick Gogerty
Language: eng
Format: epub
Tags: -
Publisher: Columbia University Press
Published: 2014-05-12T04:00:00+00:00

Valuing a Moat Differs from Normal Valuation Methods

Moats drive the valuation of a firm. In traditional valuation, the first consideration is book value, and so it is with the conservative nature of value approach. Book value is simply the estimated value of the company if all assets were sold to pay off all liabilities on the balance sheet. The remaining cash or equity owned by the shareholders is the book value. Assuming book value reflects the realizable wind-up value of the firm, it lets an investor put a loose theoretical value floor or margin of safety on the investment to minimize risk. The book value is the first and crudest way to assess investor risk.

Figure 10.6 shows a lemonade stand that produces $40/year in free cash flow (FCF). Free cash flow is made up of the operating cash flow less the capital expenditures. If a person buys the lemonade business for $90, they could shut it down, sell everything, pay off the liabilities, and pocket $10 in cash for a quick 11.1 percent return on their investment in the equity. Do that ten times a year and it promises to be lucrative.

However, valuing a firm on book value alone is a flawed method, as book value has many accounting assumptions about asset values and liabilities. For instance, book value doesn’t consider the ability of the firm to grow and create value through moated operational cash flow, cluster dynamics, or the discount prices related to a fire sale.

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