Market Efficiency and Business

¶ … valuing a business, including asset-based approaches, earnings-based approaches and market value approaches (Ward, 2016). Asset-based approaches views the business as its net asset base, but this can be inaccurate because the valuation of the assets on the balance sheet might be stale-dated. Valuation on a liquidation basis only makes sense if the business is to be liquidated; if it is a going concern, then it is probably worth more than liquidation value on those assets. The market-based approach looks at what other similar businesses have sold for.

There are a couple of drawbacks to this approach. First, you have to choose a similar company that has recently sold. There might not be any. Further, the choice of "similar company" might not actually be that similarity. There might be material differences in your corollary that render the comparison inaccurate. The earnings-based approach is rooted in the idea that a business is worth the present value of its expected future cash flows.

This method is usually the most accurate, especially if the business has relatively stable cash flows and there are no material changes in the environmental outlook. Further, this method can be valuable when the business is being taken over -- the seller can use this method to determine what the actual value of the business is to the potential buyer, which might be higher than its value to the seller.

The earnings-based approach is only really poor when there has been a material change in either the business or its environment. In such a situation, past cash flows are a poor indicator of future cash flows. Say a small business loses a key partner, and the remaining partner is now looking to sell.

But if that key partner who left was the real driver of the business, then what is now being sold will be short two key partners -- it will not be the same business going forward than it was in the past. That might be a situation where the asset-based approach works best. But in the majority of situations, the earnings-based approach to valuation makes the most sense. 2.

When you don't know a firm's specific details, it is not possible to render an opinion on whether GAAP or IFRS would be more favorable. The reality is that this is something you calculate when you have hard numbers -- math is how you answer a question like this, not opinion. I personally prefer GAAP, as I am more comfortable with it, and I feel that the statements have greater clarity. IFRS statements are not as well organized.

I also prefer GAAP's rule-based approach because as an external stakeholder you always know the basis for how something was calculated. I have a preference for hard facts and clear logic, and feel that IFRS is entirely to fuzzy in that regard -- principles are not as reliable as rules. If I was an internal stakeholder, I'd probably prefer IFRS because I'd have a lot more flexibility with respect to obfuscating the truth. But an external stakeholder cannot prefer IFRS if they actually want to understand the firm's financial position. 3.

The argument in favor of the market-based valuation method is an interesting one. It does not produce the most accurate results unless there is a corollary that is sufficiently accurate. If there is none, then the market-based approach is worthless. The reality is this. Let's say you're selling your small microbrewery. Now, if the only brewery that has been purchased lately is an industrial brewery in Romania, then what value does that really add to your small microbrewery in Topeka? So you have to have corollaries.

Now let's say there's a brewery that is around the same age and size as yours that's been sold in another state. That provides the basis of valuing your company. In those situations where there have been sales recently that provide close corollary with the company being sold, then the market based approach is likely to yield a fairly close approximation. So it is not a case of "this method is better always" but rather a case of knowing which method is better under what circumstances. 4.

In theory, markets should be pretty efficient. We don't know what market we're talking about here, but most markets today have low friction. Information is plentiful and easy to obtain. Transportation networks are well-developed. The world is leaning towards lower trade barriers and global competition (Radcliffe,2015). The Internet has created very low costs to information acquisition, which should have a positive impact on market efficiency. Basically the Internet has reduced the impact of place on information-gathering.

If one needs not travel anywhere to, say, compare prices on flashlights, or to buy one, then that is powerful in terms of efficiency. The competitor with the lowest price will win, every time. The cost of acquiring that information is very little -- a couple of quick searches, and much lower than before the.