Complexity vs. Simplicity: Knowing the Audience for Your Valuation

The world of finance and valuation, in particular, can be intimidating. Whether it’s the valuation of common stock for your personal portfolio or the valuation of a mid-market company with diversified operations generating $50 million in revenue, each analysis has one common goal: turn inputs into outputs. Period. Nothing more. Nothing less.

The rise of Big Data has enabled the rapid expansion in the number of inputs available, but the number of outputs has stayed the same — one! How much do I pay? Even for the most experienced finance professionals, the importance of each input is a point of contention. Some traders take action on purely technical indicators/inputs. Some traders take action on purely fundamental indicators/inputs. Each have academic support and backing for the use of their respective inputs. So which one is right? In typical finance fashion, the answer: it depends.

It depends on future results. But valuation, itself, is an exercise in forecasting future results, which we don’t know yet. Valuation then becomes a trade-off between incremental effort and incremental results. In order to decide where to focus your incremental efforts, it’s important to understand your audience.

Is your audience:

  • A retired couple with no previous financial experience?
  • A mid-sized company preparing for an acquisition?
  • A group of entrepreneurs that need advice on venture investments?
  • You?

Financial consulting firms may help young entrepreneurs navigate the venture capital markets. CFO consultants may assist the mid-market company preparing for an acquisition. You may be your own audience as you decide how to invest your own money. The mission of the provider—regardless of the audience—is to turn inputs into outputs, but the explanation and justification of the inputs should change between audiences.

Notice how I said explanation and justification of the inputs. Nowhere did I mention the number of inputs. It’s why valuations usually seem so intimidating. There are a ton of variables and all of them might very well contribute to incremental results in some way, but was it worth the incremental effort? Occam’s Razor says that among competing hypotheses, the one with the fewest assumptions should be selected. Many valuation professionals don’t subscribe to this line of thinking and it’s easy to see why. It’s not very exciting. Mysterious is exciting. Complicated is exciting. Simple is not exciting.

If you’ve heard of the Minimum Effective Dose, the same concept applies here. Don’t bombard your audience with inputs that are incrementally irrelevant. Explain and justify the most important inputs for the audience at hand.

 

Austin Mongan has over 6 years of finance experience, specifically in the business valuation space. Austin currently works at Drillinginfo where he focuses on providing data-driven and product-level investment decisions. Previously, he worked at KPMG in Houston where he concentrated on business enterprise valuations for strategic and tax purposes, purchase price allocations, and goodwill impairment testing.