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Valuation interview question

Why do two companies with almost identical financial statements end up being acquired at different values?

We consider two companies with very similar financial statements:

  • Same revenue ;
  • Same EBITDA ;
  • Same cash flow generation, etc.

Yet the two companies are not valued equally. Can you explain the reason behind this discrepancy?

Valorisation d'entreprise

Value calculation: Valuation is not solely determined by past performance

While a company’s historical financial records are critical, especially for mature companies, determining a financial valuation requires more than just considering a company’s past performance. A financial valuation is not only based on a company’s financial history but on its future capacity to perform and generate cash flows.

It is essential to assess the company’s potential for future performance and cash generation. Therefore, even if the two companies have similar financial statements at present, if one of them has more favorable growth and profit prospects, it can result in a disparity in their valuations.

In determining the value of these companies, other factors will also be considered besides their history, such as:

  • The markets they operate in. Indeed it could affect the future prospects of one company over the other.
  • Their competitive advantages and positioning.
  • The experience and vision of their management team.
  • The prospects and growth strategy outlined in their business plan.

Value and Price are not always the same.

It is important to note that the concepts of value and price are distinct from each other:

  • Value is the result of a theoretical exercise, calculation or comparison.
  • Price is simply what a buyer pays to acquire something.
  • 👉 As a result, the price may be higher or lower than the value.

So, why do the two companies with nearly identical financial statements have different valuations, and why can the price also vary?

External factors also play a role in investment decisions or buyouts. These factors could include:

  • Special market conditions
  • The presence of multiple buyers driving up the price during an auction
  • A buyer who is willing to pay a premium price for a specific technology, expertise, or resource.
  • Negotiations that favor the seller.

Conclusion:

The valuation process is not automatic and requires thorough research of the target company and its market. While calculating a value is one aspect, in reality, the final transaction price may differ greatly from the estimate obtained from a spreadsheet calculation.

🍫 This is why the right Twix company can be purchased at a significantly higher price than the left one!

Our training programs provide comprehensive information on the business valuation process in Private Equity, M&A, and Transaction Services, along with covering all the major valuation methods. Find these courses on our homepage.

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