Choosing listed company comparables as a proxy for a small-business valuation has always required a leap of faith. Even before COVID-19, placing a value on a group of cell phone repair shoppes by comparing their operating ratios with BT required courage.
Now, tens of millions of professional workers have lost their jobs (the US will likely record over 20% unemployment this month), millions of small businesses worldwide are shuttered and may not reopen—and the US stock markets, FTSE, and EURO STOXX are having close to their best quarters on record.
Louise Cooper, writing for The Spectator, asks a simple investment question that has broad implications for those valuing family businesses: ‘How can US shares be doing so well when the evidence of economic devastation is overwhelming?’
‘Most would assume the pandemic would highlight the benefits of the European welfare state and its ability to support households and businesses during difficult times. But that’s not what the stock market is telling us,’ she writes.
True, the S&P, FTSE 100, and EURO STOXX are down YTD, but Cooper finds much of the answer in the US Nasdaq, which is flat for 2020 because Amazon, Microsoft, Apple, Google, and Facebook have capitalised on the lockdown. ‘Thus the share prices of these tech giants have done well. Just these five firms are now worth more than $5 trillion. They represent 21 per cent of the market valuation of the S&P 500.’
If the FTSE 100 is down over 20% YTD as of June, and the five tech giants are stable, business valuers’ choice of comparables will make all the difference in any conclusion of value. Industry selects are more critical than ever, and the ratios derived or adjusted from a small group of comps can skew results beyond recognition.
Cooper, again, is quite eloquent on what’s happening to the value of the UK’s 6 million small businesses and their employees:
Many of these firms will suffer greatly during the pandemic but they are family owned, not listed on stock exchanges. Their pain and suffering and that of their employees is hidden from the FTSE indices.
The loss of value will also be hidden from any business valuation report that overrelies on poorly chosen listed company comparables.