Dealing with stubborn inflation in your valuations

With the CPI numbers coming in higher than expected, valuation experts will continue to grapple with how to assess the impact of inflation on their subject companies. During a BVR webinar on this very topic, Aswath Damodaran (New York University Stern School of Business) noted that, “even if you don’t consider inflation directly, it is still affecting your margins and your growth. You have to dig through the layers of your businesses to see how the impact plays out.”

Margin impacts: Margins (current and target) depend on the company’s cost structure. If the company has high gross margins, the cost inputs are low and (if those inputs are not commodities) inflation might not affect the margins. For example, a software company has high margins that can be 40% or 45% steady state for a simple reason: The extra unit of software it sells costs nothing to make. But, if gross margins are low, typically many cost inputs are needed to produce a product or service. For example, an air carrier has many cost inputs that are commodity inputs (such as oil), so its margins will actually get squeezed if there is high and unexpected inflation. “Operating margins capture the profitability of your business model,” Damodaran observes.

Growth/investment efficiency: When inflation becomes high and unstable, individuals and companies do not like to invest long term because it will take longer to recoup that investment. As inflation gets higher and more unstable, long-term investment tends to drop off. Unexpectedly high inflation will hurt a manufacturing company a lot more than a service company, which makes much more short-term investments.

To capture how efficiently a company is delivering growth, Damodaran uses a ratio called sales to invested capital. (Many analysts use return on invested capital, but he thinks that metric is “vastly overrated.”) Sales to invested capital looks at revenues per dollar of invested capital. What does that measure? If you are a more efficient company, you should be able to generate more revenue per dollar of invested capital. Revenue growth margins and sales to invested capital capture the business model for a company. “I challenge you to find me any nonfinancial service company where I cannot capture the business model with those two inputs,” he says.

BVR is making available free of charge a recording of Damodaran’s 77-minute webinar, In Search of a Steady State: Inflation, Interest Rates, and Value; The (Inflation) Genie Escapes the Bottle! You can access it if you click here (login required).

Cryptocurrency under the radar

At the recent AAML/BVR National Divorce Conference, this question was asked: On your client intake forms, do you have any questions about cryptocurrency? Only a very few hands were raised. Questions that need to be asked include: Do you hold any cryptocurrency? Do you believe your spouse holds any? Often, the attorney or analyst will have to ferret out this asset, and the first place to look is tax records, says Dorothy Haraminac (GreenVets). The first page of the Form 1040 asks about it, but that’s just for the current year, so that’s just a starting point. Other forms that could reveal crypto are Form 8938 (foreign assets), Form 8949 (capital gains/losses), Form 8283 (Schedule A, contributions), and Form 1099 Misc (for payments and receipts).

Another place to look is the public blockchain, she advised. Cryptocurrencies are not completely anonymous, and anybody can access the information on the internet, which is the “authoritative source” for this. Cryptocurrencies are publicly reported on online blockchain ledgers that identify users solely by their cryptocurrency addresses, which look like long strings of numbers and letters. There is no personally identifying information, such as names and locations. Therefore, the question for the client is: What are your addresses?

Session co-presenter Ed Kainen (Kainen Law Group) asked whether traditional financial records can reveal cryptocurrency. Yes, absolutely, Haraminac responded. Old-fashioned statements from the bank, credit card issuers, and investment advisors can reveal crypto transactions. You also may find something in the client’s employment agreements, she noted. She also advised bringing in a crypto specialist, if necessary, as the techniques for investigation are still evolving.

Develop your young BV staffers’ interpersonal skills

How to communicate with clients effectively is one thing young BV professionals say they need more help with from their veteran colleagues. This was one of the interesting takeaways from a panel of young valuation experts giving their perspectives on the profession during a session at the Business Valuation & Financial Litigation Super Conference hosted by NACVA.

The young generation of valuers are very tech-savvy, but interpersonal skills are a different story. Interacting with clients effectively is an acquired skill that needs to be passed down to the new generation of valuers. This can be done through some explanation, but the best way is to teach by doing—experienced experts should include young colleagues in site visits, client meetings, copy them on correspondence, invite them to a client lunch, or anything else where they can observe how to build rapport. But don’t just have them sit there—preplan some questions for them to ask. These efforts will go a long way toward developing young talent, the panel noted.

A full article, “Young BV Practitioners Speak Out About the Profession,” is in the October issue of Business Valuation Update.

Please take a survey on Excel add-ins for the GPCM

As part of BVR’s ongoing surveys related to data resources and methodologies, we’re exploring the use of Excel add-ins for the guideline public company method (GPCM). Are Excel add-ins prevalent? Which add-ins are used? What other data resources are used for the GPCM? Please take a very short two-minute survey, and we’ll present the results here in a future issue. Learn what your peers are doing! To go directly to the survey, click here. Thank you in advance for participating.

Another issue of the ASA’s journal added to BVResearch Pro

Every month, subscribers to the BVResearch Pro platform get access to new articles, books, court cases, webinar transcripts, and more that are added to the almost 20,000 pieces of content. The full archive of the American Society of Appraisers’ Business Valuation Review™ is on the platform, and the Spring 2022 issue has just been added. In this issue, Aziz El-Tahach and his colleagues discuss the benefits of warrants in ESOP transactions. Joe Thompson addresses meme stocks and the risks they pose to business appraisers. Brad Cornell and Richard Gerger revisit the dividend growth model and provide their observations on its use in practice. The issue also includes a review by Gene A. Trevino, Ph.D., of Valuing a Business, 6th edition, and an update to the International Valuation Glossary—Business Valuation. If you’re not a subscriber to the BVResearch Pro platform, the journal is available on a stand-alone basis if you click here.

All markets unstable, per KPMG valuation pros

The Q3 2022 International Valuation Newsletter from KPMG Switzerland includes articles on valuation in times of geopolitical tension, macroeconomic shifts, and microeconomic challenges. “One thing we learned over the last two to three years is that all the shockwaves we have experienced have affected industries and sectors differently,” the authors write. “There is no one-size-fits-all answer to the question of a market-adequate valuation—because there are no stable markets these days.” The issue also includes capital market data, including stock market performance, multiples, risk-free rates, country risk premia, and inflation forecasts. To download the issue, click here.

Preview of the November 2022 issue of Business Valuation Update

Here’s what you’ll see:

• “BVR Responds to Hitchner Article on DealStats” (Adam Manson, BVR director of valuation data). This is a response to an article by Jim Hitchner discussing the various transaction databases including BVR’s DealStats. It gives an additional perspective on the private buyer transactions in DealStats

• “Recap of the AAML/BVR National Divorce Conference” (BVR editor). It was a happy marriage of divorce attorneys and financial experts who gathered together for the AAML/BVR National Divorce Conference in Las Vegas. The AAML is the American Academy of Matrimonial Lawyers. Here are some highlights from some of the sessions.

• “New Pepperdine Report Creates Buzz at the NACVA Conference” (BVR editor). One of the more well-attended sessions at the Business Valuation & Financial Litigation Super Conference hosted by the National Association of Certified Valuators and Analysts (NACVA) was a session Dr. Craig R. Everett conducted. He is the project director of the Private Capital Markets Project from Pepperdine University, which does an ongoing survey of expected rates of return of providers in the private capital market.

• “Ang Offers SSBV Members More Evidence of the Lack of a Size Effect” (BVR editor). Clifford Ang (Compass Lexecon), who offered an impassioned plea to a large group from the UK’s Society of Shares and Business Valuers (SSBV), has become one of the leading proponents of eliminating or minimizing the traditional size premia. Ang has written a number of articles on the size effect, and he has a new book, Applied Valuation, due out early next year.

• “Estimating the Extra Risk of Customer Concentration” (BVR editor). Interesting comments were made by Roger Grabowski (Kroll), who conducted a session at the American Society of Appraisers International Conference. He discusses the research in this area and how to examine the customer concentration of guideline public companies.

• “The Two Most Prevalent Methods for Solving the Goodwill Conundrum” (BVR editor). Remarks from a session at the AAML/BVR National Divorce Conference conducted by veteran valuers Jay Fishman (Financial Research Associates) and Ken Pia (Marcum) who were joined by attorney Thomas J. Sasser (Sasser, Cestero & Roy).

The issue also includes:

• A full section of “BV News and Trends/Global BV News and Trends”;

• Regular features: “Ask the Experts” and “Tip of the Month”;

• BV data spotlight: “DealStats MVIC/EBITDA Trends,” “Stout Restricted Stock Study and DLOM Calculator,” “Economic Outlook for the Month,” and the “Cost of Capital Center”; and

• BVLaw Case Update: The latest court cases that involve business valuation issues.

To stay current on business valuation, check out the November 2022 issue of Business Valuation Update.

BV movers . . .

People: Three valuation professionals have been admitted as partners at Chicago-based BDO USA in its Valuation and Capital Markets Analysis Group: Steven Kurtz, MAI, MRICS (New York City), whose focus areas are real estate, valuations, and advisory; Vincent Mercader, ASA (Detroit), who provides valuation consulting services; and Chrissa Qiu, whose areas of focus are valuations of intellectual property, portfolio investments, complex capital structures, and equity allocations.

Firms: Columbus, Ohio-based GBQ Partners LLC is spinning off its valuation and employee stock ownership plan (ESOP) advisory teams into a new entity—GBQ Capital Advisors—that will continue to specialize in the valuation of businesses, business interests, and intangible assets in the context of transaction advisory, financial reporting, ESOPs, shareholder transactions and buy-sell agreements, equity-based compensation, estate and gift planning, and various corporate-related matters … Further expanding its footprint in Southeast Asia and Australia (SEAA), Alvarez & Marsal (A&M) has opened a new office in Vietnam … San Francisco-based BPM LLP has launched a new data analytics service that aims to help clients make data-driven decisions to propel growth, manage their risks, and improve overall business performance … Dubuque, Iowa-based Honkamp Krueger & Co. will now be known as Honkamp PC, and the firm has also unveiled a revised logo.

Please send your professional and firm news to us at editor@bvresources.com.

CPE events

• Leases Pieces—Digesting the New Accounting Standards and Business Valuation Impacts, October 19, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Michelle F. Gallagher (Adamy Valuation), Jacob Helwick (Adamy Valuation), Sara Fetke-Sweers (BDO), and Chris Hickmann (BDO). CPE credits: 2.0.

The new ASC 832 lease standard is reviewed, including a breakdown of its accounting implications and presentation in GAAP financial statements and the methods that ensure these changes are properly addressed in a valuation context.

• Power Panel: Avoiding Common Business Valuation Mistakes, October 25, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Jay E. Fishman (Financial Research Associates), Gary Trugman (Trugman Valuation), and James Hitchner (Financial Valuation Advisors). CPE credits: 2.0.

The panel will use their many years of experience to demonstrate what common errors they are seeing in the real world and how to avoid them. It is intended as an interactive discussion that will serve as a learning experience for the newbies and a refresher for the more experienced practitioner.