Types of Intervention by Central Banks in Forex Markets
When Do Central Banks Intervene in the Forex Market ? Central Banks do not intervene often in the Forex market. In fact, the intervention by Central Banks can be considered to be a sign of significant economic weakness in a currency. As a result, Central Bank intervention usually only happens when the currency is under […]
Public-Private Partnership in Stadium Financing
In the previous articles, we have already seen that funding a stadium can be very difficult from a financial point of view. The financial aspects of stadium financing can be challenging regardless of whether the financing will be provided by the government or by private parties. It is important to note that stadium financing can […]
Ordinary Annuity vs. Annuity Due
Annuities can be divided into two types based on the exact time when the payments occur in a given period. The payments could either occur at the beginning of every period or the payments could occur at the end of every period. For instance when you take a house on rent, the rent is usually […]
Why are Investors Getting Spooked by an Inverted Yield Curve?
In the past week, the American investors witnessed an inverted yield curve for the first time since the year 2007. An inverted yield curve is one of the most tell-tale signs that a recession is around the corner. This is the reason why the sighting of the yield curve sent both the equity as well […]
Reverse Factoring – Meaning and its Benefits
The purpose of commercial banking is to help corporations meet their funding needs in a better manner. Commercial banks help companies do this in several ways. One such way is related to the concept of reverse factoring. Reverse factoring is a solution that helps large corporations manage their supply chains better by helping optimize the […]
Equity valuation is usually conducted for an entire enterprise. For instance, if we are trying to come up with a valuation for Apple Inc, we will usually consider Apple Inc as being one single indivisible unit. This is because the cash flows that will accrue to Apple Inc are intertwined and all of the cash flows to the same company have almost the same level of riskiness.
This approach may be useful for companies which have one single business focus i.e. most of their business is concentrated in one industry only. An example would be Apple Inc which is largely involved in the consumer electronics industry.
However, it is not very useful for companies which have diverse business interests. For instance consider the case of Berkshire Hathaway which is the holding company headed by Warren Buffet. Berkshire Hathaway has business interests in insurance, railroads and even diary. Obviously the risks and rewards facing each business are very different. Hence, it would not be prudent to value the entire company as one indivisible unit. Rather, it would be more appropriate to value each line of business that the company has and then add these cash flows together to arrive at the final valuation.
This approach of conducting a valuation of individual lines of business and then adding these values to derive the corporate valuation is called the sum of the parts valuation approach. It may also be referred to as breakup value by many investors.
Closely linked to the idea of sum of the parts valuation is the idea of a conglomerate discount. The concept of conglomerate discount says that investors prefer companies which have a single minded focus i.e. they sell similar or related products. When companies diversify too much and enter into unrelated business, investors supposedly mark down the valuation of the company because of loss of focus. This markdown is called conglomerate discount.
Therefore, if a conglomerate has 3 lines of business A which is valued at $10 million, B which is valued at $25 million and C which is valued at $15 million, then the ideal sum of the parts valuation should be $50 million. However, conglomerate discount implies that the stocks of the combined entity will trade at an amount less than $50 million, let’s say $47 million because investors are wary that the company is losing focus and may not excel at either of its businesses.
The idea that conglomerates do not perform as well as focused companies is grounded in a lot of research. Some of the factors which justify the existence of conglomerate discount are as follows:
The existence of conglomerate discount is still a hotly debated topic. Some analysts argue that there is no discount as such and the company’s are plain and simple undervalued in the market. However, other analysts argue that it has to be quite a coincidence that almost all the conglomerate companies are more or less undervalued in the market.
Either ways, as an analyst, we must be aware that unrelated businesses belonging to the same conglomerate can be valued using the sum of the parts valuation. Also, there is a possibility that the corporate value may be lower than the value reached by adding the individual parts. This could be caused by conglomerate discount.
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Calculating Free Cash Flow to the Firm: Method #2: Cash Flow From Operations
February 12, 2025
