banner ad
Experts Logo

articles

Regression Analysis in the Market Approach: Using the Gordon Model as a Guide to Selection of Independent Variables

Originally published in The Value Examiner, March/April 2012

By: Jay Abrams, ASA, CPA, MBA
Tel: 818-505-6008
Email Mr. Abrams


View Profile on Experts.com.


Introduction

Regression analysis is a statistical technique to measure the mathematical relationship between a dependent variable and one or more independent variables. In the context of the Market Approach in business valuation, the dependent variable is usually some variation of Fair Market Value (FMV), i.e., market capitalization in the Guideline Public Company method, selling price (IBA), or MVIC (Market Value of Invested Capital, Pratt's Stats). We can use the dependent variable in dollars or as a scaled variable, i.e., divided by sales, earnings, EBIT, etc.

Confessions of a Reformed Quant

I have used regression analysis in valuation ever since I started in the valuation profession in 1983. I used it on my very first valuation-of a major motion picture producer-to forecast syndication revenues as a function of either theatrical revenues or television revenues. (It turned out that the latter was statistically significant, not the former.)

Regressions are enjoyable to perform, and they can be very powerful. It is much harder to argue with a well-done regression than with mean or median multiples with subjective adjustments. One of the great benefits of regression is its objectivity and rich statistical feedback to provide information on its own reliability.

As regression textbooks tend to be very general, they do not address many issues that are specific to business valuation. The textbooks give us the basic tools. They tell us how to use the tools, but not where to use them. Much of what I have learned about using regression analysis has been from experience-a combination of trial-and-error, seeing what works and what does not, and thinking about how to do it better.

In my early years I enjoyed regression so much that I was willing to do "the shotgun approach"-regressing the dependent variable(s) against 100+ independent variables. Even for a quant like me, eventually this became tiring and is very unprofitable on fixed fee assignments. There had to be a better way.

Eventually I realized the need to develop a theoretical model as a guide to tell me where to look for independent variables and-equally as important-where not to look.

Theoretical Relationships between FMV and Valuation Drivers

In this article we develop the theoretical relationship that should exist between FMV and the valuation drivers, i.e., the independent variables that affect value, e.g., income, cash flow, risk, growth, etc. The importance of doing so is:

  1. To reduce the risk of data mining, which is finding apparently statistically significant relationships that are in reality the result of chance through brute force regression analysis of many dozens of variables.
  2. To save time by not having to test independent variables that should have no theoretical relationship to FMV.

The Gordon model multiple is the logical place to start, as it is the value equation of a mature firm. Before diving into it, let's begin with some algebraic definitions.

Definitions

. . .Continue to read rest of article (PDF).


Jay Abrams, ASA, CPA, MBA, founder and head of Abrams Valuation Group (AVG), is one of those rare individuals who integrates theory and practice. He has valued businesses and consulted on mergers and acquisitions in a wide range of industries, provided valuations and discounts for fractional interests and restricted stock, and conducted independent statistical and mathematical research regarding problems facing businesses. During his 25 years of accounting and valuation experience, he has made, and continues to make, significant contributions to the science of valuing businesses. Mr. Abrams' book, Quantitative Business Valuation: A Mathematical Approach For Today's Professionals (McGraw-Hill, 2001) shows how to integrate advanced scientific methods into real-world valuation analysis.

©Copyright - All Rights Reserved

DO NOT REPRODUCE WITHOUT WRITTEN PERMISSION BY AUTHOR.

Related articles

Norcal-Valuation-Logo.gif

7/17/2014· Appraisal & Valuation

Appraising Unique Assets

By: Jack Young

RN's Beverly McFarland and her associate, Kevin Whelan of The Beverly Group, Inc., recently gave a presentation in San Francisco to the Northern California Chapter of the American Society of Appraisers ("ASA") on "Challenges of Appraising Special Assets". The emphasis was on the appraisal of assets in chapter 11 bankruptcies and receiverships and the differences between the two entities and how they are administered. Through the new acquaintances that we met that evening, we discovered some fascinating appraisals that members of the ASA have completed that we would like to share with Receivership News readers.

thomas_kalajian_photo.jpg

3/17/2010· Appraisal & Valuation

Introduction To Business Valuation Concepts For Attorneys

By: Thomas Kalajian, BS, CRTP, AVA, ABAR

This article is intended to provide a conceptual introduction of business valuation for attorneys who seek a confirmation of the fundamentals, disabuse from common misleading notions, or practical tips to assess the quality of valuation reports encountered in their practices. Business valuation is a broad and technically challenging discipline.

Samnik-Ballard-tree-Consultants-logo.gif

4/22/2014· Appraisal & Valuation

Tree Risk Assessment: The More Things Change, The More They Stay The Same

By: Joe Samnik

The title is certainly an old play on words and, perhaps correctly, states the fact that no matter how radical a change the underlying components remain the same, as do the consequences. Such is true in many industries and ours is no different. Take the ANSI A300, (Part 9), and the companion publication, Best Management Practices (BMP) Series Tree Risk Assessment, regarding the assessment of tree risks.

;
Experts.com-No broker Movie Ad
Unicourt Logo Button

Follow us

linkedin logo youtube logo rss feed logo