119 common errors in company valuations

by Pablo Fernandez and Andrada Bilan
Download as PDF IESE Business School, University of Navarra, Madrid, Spain

This document contains a collection and classification of 119 errors seen in company valuations performed by financial analysts, investment banks and financial consultants.
The author had access to most of the valuations referred to in this paper in his capacity as a consultant in company acquisitions, sales, mergers, and arbitrage processes.

We classify the errors in six main categories:
1) Errors in the discount rate calculation and concerning the riskiness of the company;
2) Errors when calculating or forecasting the expected cash flows;
3) Errors in the calculation of the residual value;
4) Inconsistencies and conceptual errors;
5) Errors when interpreting the valuation;
6) Organizational errors.

1. Errors in the discount rate calculation and concerning the riskiness of the company
1. A. Wrong risk-free rate used for the valuation.
1. B. Wrong beta used for the valuation.
1. C. Wrongmarket risk premium used for the valuation.
1. D. Wrong calculation of WACC.
1. E. Wrong calculation of the value of tax shields.
1. F. Wrong treatment of country risk.
1.G. Including an illiquidity, small-cap,or specific premium when it is not appropriate

2. Errors when calculating or forecasting the expected cash flows
2. A. Wrong definition of the cash flows.
2. B. Errors when valuing seasonal companies.
2. C. Errors due to not projecting the balance sheets.
2. D. Exaggerated optimism when forecasting the cash flows.

3. Errors in the calculation of the residual value
3. A. Inconsistent cash flow used to calculate the value of a perpetuity.
3. B. The debt to equity rati used to calculate the WACC for discounting the perpetuity is different than the debt to equity ratio resulting from the valuation.
3. C. Using ad hoc formulas that have no economic meaning.
3. D. Using arithmetic averages instead of geometric averages to assess growth. 3. E. Calculating the residual value using the wrong formula.
3. F. Assume that a perpetuity starts a year before it really starts

4. Inconsistencies and conceptual errors
4.A. Conceptual errors about the free cash flow and the equity cash flow.
4.B. Errors when using multiples.
4.C. Time inconsistencies.
4.D. Other conceptual errors

5. Errors when interpreting the valuation
Confusing Value with Price.
Asserting that a valuation is "a scientific fact, not an opinion."
Considering that the goodwill includes the brand value and the intellectual capital...

6. Organizational errors
6. A. Valuation without any check of the forecasts provided by the client.
6. B. Commissioning a valuation from an investment bank and not having any involvement in it.
6. C. Involving only the finance department in valuing a target company.
6. D. Assigning the valuation of a company to an auditor.

Appendix 1. List of errors.
Appendix 2. A valuation with multiple errors of an ad hoc method

Full paper available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1025424
For direct link to PDF, click here.

Reproduced on www.reportwatch.net by kind permission of the author, and made available thanks to the Social Science Research Network (http://papers.ssrn.com/).
Spanish version: http://ssrn.com/abstract=962921

back to overview

Best annual reports

Annual Report on Annual Reports 2018

Report pick

December 2017: Phoenix Mecano
Phoenix Mecano
Stein am Rhein, Switzerland « View our previous picks

Financial sector annual reports

Evaluation - Competition

Annual reports from the financial sector are no longer selected for the Annual Report on Annual Reports competition for consistency, comparability and credibility reasons. That does not imply that there are not (sometimes very) good and improved reports in the sector. On a customized basis, e.com keeps on evaluating and benchmarking financial sector reports.

How is your report doing?

The report scan

How is your report doing? How does your annual report score on all evaluation criteria used for the Annual Report on Annual Reports?

Order a REPORT SCAN. An edited output of desk research done by e.com report analysts, it provides your company (or advisers) with a summary of pluses and minuses for 25 report items and reporting areas.

For more information, click here.

E-mail your order to: e.com@reportwatch.net

Report, Google and watch

Has a/your report appeared on ReportWatch?

Has a/your (company) report/name been mentioned, watched, rated, ranked, benchmarked, cited on ReportWatch?
Or has ReportWatch been cited with reference to a/your company/report/name?
Type the (company) name followed by ReportWatch (in one word) and see if you get results.


Mike 4 faces

e.com's co-founder and ReportWatch kingpin Mike Guillaume wears a few hats, including financial reporting specialist and international economist, and has therefore good vantage points for monitoring companies, reports and management; as well as for watching economies and economics work (or not). Learn more about Mike's experience and expertise here. Read about Mike's work and views, including his recent book "The Seven Deadly Sins of Capitalism", on www.mikeconomics.net.