Market Valuations Variability is a concept that is not well recognized in many of the transactions. Investment decisions are typically informed by detailed, quantitative models, which provide investors with an understanding of how the market values different companies. However, it is not always clear how corporate managers can obtain similar insights, in order to make informed decisions that maximize shareholder value.
An analysis by EY-Parthenon of quarterly data from thousands of companies across hundreds of industries over a 20-year period has identified six critical factors that account for the majority of the variability in market valuations. These factors are:
- weighted forecasts of growth in company revenue;
2. weighted forecasts of growth in company margin;
3. patterns of cash returned to shareholders;
4. changes in the company’s debt-to-equity ratio;
5. the economic conditions in the company’s industry; and
6. market volatility in the geographic areas in which the industry’s major companies compete.
By focusing on these key drivers, management teams can create a near-universal model that allows them to compare industries, companies across industries, and companies within the same industry. This approach can also help leaders understand changes in how the market values any of these companies over time.
The traditionally employed methods for managing valuations, such as improving price-earnings (PE) ratios through driving revenue and margin based on historical heuristics, may not be as effective. Such a method is imprecise and may not provide an accurate understanding of a company’s position in the market, thus inhibiting a company’s ability to recognize opportunities and neutralize threats.
Given the importance of understanding market valuations, it is crucial that corporate managers adopt more quantitative, detailed methods in order to make informed decisions. Such methods will not only provide managers with a better understanding of how their companies are valued, but also help identify opportunities and threats within the market. In addition, boards of directors would also be able to gain valuable insights into whether valuation changes are being driven by company or market conditions, and how attuned management is to these shifts.
As reported by EY-Parthenon, by focusing on these six critical drivers, management teams can not only get a better understanding of how the market values their company, but also identify opportunities and threats within the market. Moreover, boards of directors would also be able to gain valuable insights into whether valuation changes are being driven by company or market conditions, and how attuned management is to these shifts.
In conclusion, the use of a comprehensive and data-driven approach to understanding market valuations and the factors that drive them can greatly benefit corporate managers in making informed decisions that maximize shareholder value. A thorough analysis of the key drivers of valuation such as growth in revenue and margin, cash returned to shareholders, debt-to-equity ratio, industry conditions, and geographic market volatility, as demonstrated by the EY-Parthenon study, allows companies to create a near-universal valuation model and adapt their strategies accordingly. By combining this model with other financial analysis tools, companies can have a well-rounded understanding of their performance and positioning in the market, and make strategic decisions accordingly.
Smith, J. (2022, October). 6 Factors That Determine Your Company’s Valuation. Harvard Business Review. Retrieved from https://hbr.org/2022/10/6-factors-that-determine-your-companys-valuation