COVID-19 has substantially affected the financial and economic characteristics of privately held and publicly traded businesses, particularly in regard to:

• Capital markets and M&A activity;
• Applying the discounted cash flow method;
• Applying the guideline public company method; and
• Applying the merger and acquisitions method.

Last month, Daniel R. Van Vleet, ASA; David Neuzil, CFA; and Joseph Thompson, CFA, ASA (all three are partners at The Griffing Group) addressed the potential distortions that can occur when traditional business valuation approaches and methods are mechanically applied. In Alternate Valuation Methods in the Era of COVID-19, Van Vleet, Neuzil, and Thompson argue that analysts need to think ‘outside the box’ when performing business valuations with valuation dates occurring during the first and second quarters of 2020.

They are particularly concerned that financial analysts avoid leaving themselves exposed by comparing ‘impaired’ comparables with ‘unimpaired’ assets. Now, experts ‘really need to use some caution and think about whether or not the valuation multiple that they are deriving accurately reflects COVID-19,’ says Thompson.

‘The valuation date for your particular assignment will determine how you conduct your valuation,’ Van Vleet confirms—because the ongoing volatility is different from any of the past economic disasters. The third week in March is pivotal since that’s the date when the LSE and US markets hit their cyclic lows.

Those using the DCF for financial reporting or other purposes face similar challenges with their cost of capital assumptions. ‘If you are just mechanically applying a cost of capital analysis, for instance, using a CAPM model or a buildup method of some type where you are using a risk-free benchmark as your basis to build your equity rate, you would potentially quantify a cost of equity capital that is lower in today’s current environment than what you would have back at the end of last year. That doesn’t necessarily make sense,’ Van Vleet demonstrates.

The Griffing Group suggests an adjustment to normal business valuation procedures to avoid double counting the impacts of COVID-19. ‘What we determined as a way to address this is to adjust the affected earnings of the subject company to quantify the unaffected earnings of that subject company, which we just called the unaffected earnings,’ Van Vleet explains. ‘If we applied the affected GPC multiples to the subject company’s affected earnings, a double counting error may occur because there is a false comparison going on there.’