Ashok Abbott's liquidity research continues to provide answers for current DLOM/DLOL calculations
Is there a distinction between discounts for lack of liquidity (DLOL) and discounts for lack of marketability (DLOM)? Moreover, what is the maximum DLOM today? The standing room only crowd at Dr. Ashok Abbott’s session at this week's FAE/BVR 2009 Business Valuation Conference in New York City was hungering for a cogent methodology to fully measure, without double counting, discounts resulting from today's volatile marketability and liquidity situation.
Indeed, the recession has increased discounts to the point that, for many current valuation engagements, they are the single most material conclusion. Although they’ve improved in the last months—particularly for small cap companies—discounts for lack of liquidity are still much higher than they were in 2005 or in other historically high periods, Abbott explained at Monday’s meeting. Abbott, an Associate Professor of Finance at West Virginia University and Senior Appraiser at Business Valuation LLC, said this fact makes life extremely difficult for anyone calculating DLOM or DLOL for current valuation dates.
In addition, rapid changes are continuing. “A small cap large block of stock that might have had a DLOL of around 40% in November 2008 is now showing 20% using current public market data,” he explained.
Because of the unprecedented volatility in this major valuation factor, BVR is hosting a special recast on Thursday, May 21, at 10:00am PT/1:00pm ET of Dr. Abbott’s highly successful session, Liquidity Crisis and Valuation Practices—Estimating the Cost of Liquidity. A live Q&A with Dr. Abbott will follow the presentation. Two CPE credits are available for this 100-minute teleconference. Click here to register.
Want additional insights on how to quantify liquidity discounts? To download a copy of Dr. Abbott’s 2007 article, “New Abbott Analysis Aids Valuators in Assessing Liquidity Discounts,” visit our Free Resources page. You can also check out the Abbott Liquidity Factor in the Business Valuation Update™. The Abbott Liquidity Factor is a measure derived from a liquidity database developed by Dr. Abbott, which tracks directly observable data for common stocks of publicly traded securities from the primary national exchanges (NYSE, AMEX, and NASDAQ).
Four Web sites help BV experts take their BV reports from good to great
There were a number of useful takeaways from Darrell Dorrell’s session at the two-day 11th Annual FAE/BVR Business Valuation Conference earlier this week in NYC. However, the ones that seemed to resonate most with attendees were based on a simple, yet often overlooked premise: With a few simple steps, you can take your appraisal reports from good to great, while enhancing your reputation as a top notch professional who goes the extra mile by providing an additional layer of information. This two-hour lecture touched on many in-depth and technical topics, but also emphasized the need to look externally, such as investigating transactions/interactions with suppliers, customers, investors/lenders, regulators and employees.
The firm that Dorrell helped found—Lake Oswego, Oregon-based Financial Forensics®—has accomplished much work in the field, including everything from assisting the FBI in identifying money laundering and other white-collar crimes to providing technical advice to the Law & Order television series. Consequently, it seemed only fitting that Dorrell offered insights on what he called “cookies on the bottom shelf”—or covert forensic tools. Among them were four Web sites that generated a lot of “buzz” among attendees:
- Black Book Online is a free site that allows users to conduct searches of information contained in the public record. Dorrell said that he finds something useful almost every week by using the site’s reverse look-up tool. For example: A husband in a matrimonial case claimed he had only one business. The reverse look-up feature revealed that he owned four.
- Veromi is a reasonably priced, paid site that delivers data on facts like previous employers, prior marriages, and even former roommates. According to Dorrell, this site is most effective in showing relationships that may not otherwise come to light. “Look at the relationships. Identify those relationships, and you’ll find the money,” Dorrell said.
- StatSoft is an “electronic textbook” with what Dorrell described as “extraordinary detail on statistical techniques.”
- The Financial Crimes Enforcement Network, a U.S. Treasury site, is also worth a quick look.
Another practical takeaway: Dorrell recommends using pictures in your valuation reports. They help convey the context for the readers’ benefit. Dorrell also recently spoke about this same subject at the Portland, OR, ASA chapter meeting. He provided BVR with a PDF of his PowerPoint presentation which is available on the Free Resources page.
Top 10 issues related to the selection of Cost of Capital (COC) data
To estimate the cost of capital (COC)—what investors in a certain business interest or security expect as a future rate of return—is a “daunting task,” Robert Reilly of Willamette Management Associates told the roughly 120 attendees (and 60 webinar registrants) at the CalCPA Education Foundation’s 2009 Business Valuation conference in San Francisco this past week.
As in prior years, this one-day confab focused on a single, cutting-edge topic, developed through several sessions and a notable array of expert speakers, among them: Roger Grabowski (COC for distressed companies); James Harrington (application of the Morningstar/Ibbotson’s data); Keith Pinkerton (capturing company-specific risk with the Butler/Pinkerton Model), Brian Brinig and Jeff Kinrich (calculating the discount rate in economic damages); and Kevin Yeanoplos (cap rates for small businesses).
Conference chair Ted Israel (Eckhoff Accountancy Corporation) noted both the depth and liveliness of the discussion this year, particularly in light of the current economic crisis and the difficult questions that now confront business appraisers and analysts in what was always a challenging task.
As Reilly remarked, “We need to extrapolate from data that we have a lot of, to derive data about which we have little to no data.” Of course, he’s talking about taking historic, public company investment and pricing data from such sources as Ibbotson/Morningstar or Duff & Phelps, Bloomberg or Capital IQ, and applying them to the “generally accepted” models such as CAPM, modified CAPM, or the Build-up method. “They are the best models and data that we have,” Reilly noted, “just not necessarily the data we wish we had.” Analysts shouldn’t “over-obsess about precision,” however. “We can get to a very precise answer, but at the end of the day, we will still have to use our professional judgment”—now more than ever, he noted, given the continued volatility of the markets and its current “aberrational” data.
What analysts really need to focus on is identifying the concerns and questions related to the selection of COC data. “There are no right or wrong answers, necessarily,” Reilly said, just issues that analysts need to talk about and applications they need to understand. With that in mind, here is Reilly’s “short list” of the top ten issues related to COC data:
- Risk-free rate of return measurement
- Appropriate historical time period for the equity risk premium
- Size effect equity risk premium measurement
- Beta measurement—levered or unlevered
- Beta measurement—appropriate market proxy
- Beta measurement—appropriate time period
- Beta measurement—appropriate frequency of data observations
- Beta measurement—appropriate adjustment factors
- Industry equity risk premium measurement
- Company-specific equity risk premium measurement
To read more details on Reilly’s “Top Ten Conclusions” from the CalCPA conference, look for an article in a forthcoming (July 2009) Business Valuation Update™.
Abstracts linked to court opinions at the updated BVLibrary
BVR has recently completed programming at our BVLibrary.com Web site to “link” court case abstracts from Deluxe BVUpdate with their corresponding full-text court opinion from BVLaw. Here’s how it works: After a user retrieves an abstract using the search engine on our site, a link will be provided at the top of the page to view the full-text court opinion—and vice versa if the user first retrieves the full-text court opinion. Subscribers to both products can easily pass back and forth between the abstract and the full-text opinion.
Free trials to Deluxe BVUpdate and BVLaw are available to practitioners who want to give them a whirl by contacting firstname.lastname@example.org or by calling 503-291-7963 X2.
No BVWire next week
Due to the Memorial Day holiday and our coverage of NACVA and the IBA's 2009 Annual Consultants' Conference on May 27−30 at the Westin Boston Waterfront, your next BVWire will appear on Wednesday, June 3.