I have wrestled with this question for many years, and I have gradually converged on the following formula for determining the worth of a company:
Company Worth equals “Company Liquidation Value” multiplied by a market factor.
“Company Liquidation Value” is the 30-day market liquidation value of the tangible assets, minus the liabilities. It does not consider INTANGIBLE assets, such as Intellectual Property (IP) or such intangibles like “Customer Goodwill”. The value of those intangibles are instead captured by the “market factor”.
Assuming the company in question keeps a good set of GAAP accounting books (Generally Acceptable Accounting Principles), the place to start with the tangible assets valuation is the Balance Sheet. Then you go through each of the tangible assets line-by-line, and revalue them as follows:
* Cash & Marketable Securities: 100%
* Accounts Receivables: 80%
* Inventory: 67% of original cost
* Prepaid Expenses: 25% of original cost
* Vehicles: 80% of current GAAP balance sheet value.
* Land & Buildings: 100% of original cost (pending an independent valuation from a qualified real estate agent, whereupon you use their low-range valuation)
* Other Fixed Assets: 15% of original cost (pending an independent valuation from a qualified agent, whereupon you use their low-range valuation)
If you take the above asset values, and then minus the liabilities, you have the liquidation value of the company, which is the amount of cash you could bring in within about 30 days by liquidating the assets.
A company is typically worth MORE than its liquidation value, so that’s where the “market factor” comes in.
The “market factor” calculation is very subjective, but as a rule of thumb, I would never go higher than 3. For example, if a company’s liquidation value is $1M, and if you use a “market factor” of 3, then the company’s value is $3M.
For a publicly traded company, if the liquidation value (as calculated above) is less than the company’s market cap (outstanding shares multiplied by the price-per-share), then such a company has a “market factor” less than 1. Such a company is worth more dead than alive, and such a company runs a risk of being raided by corporate raiders, shut down, broken up, and sold off. And yes, that happens.
I believe a “market factor” between 1 and 3 is typical of a healthy company. I would start with a 1.5, and then go up or down depending on what I discover. Some will argue with that, saying things like “my company is unique because it operates on a drop-ship model and has no need of inventory”. I do not consider drop-ship a sustainable business model for a large number of reasons (one of which is that it puts your reputation in the hands of a 3rd party that you have no control over, and another one of which is that Amazon is going to kill you). So a company that argues it has no need of inventory will make me LOWER its market factor, not RAISE it.
If I discover substantial IP (Intellectual Property), I would raise the “market factor” higher than 1.5. But I don’t think I would ever go higher than a “market factor” of 3. I have made that mistake in the past, and I won’t make it again in the future.