How long will high inflation last?

BVWireIssue #241-4
October 26, 2022

valuation methods & approaches
economic forecast, projections, economic conditions

The U.S. economy will be returning to a more normal level of inflation by late 2023 and heading into 2024, according to published research presented during a recent BVR webinar conducted by William Harris (Trugman Valuations). In the short term, valuation analysts should examine their subject company’s industry to assess the impacts of inflation because not all industries have been impacted the same, Harris pointed out. At his firm, he has seen some companies struggling with supply-chain issues and rising input costs, while other companies have been able to pass through these costs successfully to end users. Therefore, a thorough understanding of how the current economic environment impacts the subject company is essential, he stresses.

Methodology: Because of the current economic picture and the events that have impacted the last few years of historical financials, the capitalized cash flow (CCF) model has given way to the discounted cash flow (DCF) model, Harris notes. He also advises that, with the market approach, an understanding about how the current inflationary environment impacts guideline public company multiples and transaction multiples is also essential. Historically, high levels of inflation have driven down publicly traded and M&A multiples and have eroded corporate earnings. Stock prices have tended to be lower as investors have increased their required rate of return expectations. With respect to the M&A market, deal volume has historically declined in high inflationary environments and multiples have tended to be lower. This is largely due to the increased financing costs since the Federal Reserve tends to fight inflation by raising interest rates, which makes financing transactions more expensive.

Harris wrote two articles in the October issue of Business Valuation Update explaining the valuation impacts of high inflation, which also includes a case study of an income forecast that takes high inflation into account.

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