By way of macroanalyses of the entire BIZCOMPS database, Toby Tatum (Alliance Business Appraisal) demonstrates in a recent BVR webinar the ideal minimum number of comps to use in a valuation engagement (30). He also reveals that the use of comps from anywhere in the country is acceptable as is the use of comps from past years.
He explains why it is necessary for the analyst to make subjective adjustments to the comparable transaction's initial selling price (SP)-to-seller’s discretionary earnings (SDE) multiple to reflect the subject company's superior or inferior value relative to the theoretical average company and to adjust for the size effect. He presents five acceptable methods to calculate the average SP-to-SDE multiple from an array of comparables and three ways the analyst should never use.
Eliminate outliers: Tatum emphasizes that comparable transaction data should be adjusted to eliminate statistical outliers along with various other ways he uses inferential statistics when using the BIZCOMPS database. According to him, it is safe to assume that extremely high selling prices are not representative of transactions that reasonably comport with the definition of fair market value and, therefore, it is appropriate to eliminate them from the analysis. In his valuation reports, he includes this quote from Gary Trugman’s book, Understanding Business Valuation: “Just keep in mind that the market [i.e., comparable transactions] should represent a rational, knowledgeable buyer and not the biggest sucker who will pay the most for the property. Suckers don’t count!”
Tatum introduces Tatum's Law of Market Multiples and thereby provides mathematical proof that the selling price-to-sales revenue market multiple never yields a valid indication of a subject company's value.
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