Do you first see a man playing the saxophone or the face of a woman?
How can different folks viewing the same image see different things? These types of images are fun and there are the reasons that we see what we see which involve human psychology and how the brain works.
In terms of a business valuation, how can the conclusion of value for the same auto dealership be different?
Arriving at Different Conclusions of Value
We have heard it said that if you have ten different business appraisers perform a valuation of the same auto dealership, they might arrive at ten different conclusions of value. That doesn’t sound comforting. How is this possible? In the previous two-part blog series on Levels of Value (here and here), we discussed a few potential reasons.
Values can differ due to the appropriate level of value for the intended valuation or due to the purpose of the valuation. Values can also differ because the valuation process is both an art and a science. The science of valuation includes the three valuation approaches (asset, income, and market) as well as the valuation process (due diligence and financial modeling). The artful part of valuation incorporates all of the underlying assumptions including the appraiser’s understanding, interpretation, and support for each.
Valuations can also differ depending on the Standard of Value used in the valuation. The three most common standards of value are fair market value, fair value, and strategic/investment value. A brief definition of each is as follows:
- Fair Market Value – The price exchanged between a willing buyer and a willing seller, both being informed of the relevant facts, and neither being under compulsion to buy or sell (generally includes the application of discounts for lack of control and marketability where applicable)
- Fair Value – Generally assumed to be fair market value without consideration of discounts for lack of control and marketability
- Strategic/Investment Value – The value to a particular investor or buyer based on their individual requirements and expectations. Because certain investors are able to generate higher returns from the same assets due to strategic opportunities, they can pay a higher price than other potential buyers and achieve the same level of return
The Difference Between Value and Price
The difference can also be explained by the difference between price and value. For a public company, these terms are supposed to be synonymous. In other words, the value of a share of Apple stock is equal to the market price of the equivalent share on a given day. Then again, if the price of every public stock was exactly what it was worth, would Warren Buffet be a billionaire?
While the terms price and value are often used interchangeably, their meaning may not be synonymous in the context of a private business, or in this case an auto dealership. In this post, we examine the differences between price and value.
The Price of an Asset or Business
Conversely, the price of an asset or business is governed by the supply and demand for that asset. As demand for an asset increases, the price will increase. As supply for an asset decreases, the price will increase. We are seeing the negative impact when both conditions exist in our daily lives with the prices of new and used automobiles, along with most consumer goods. This is also true for auto dealerships themselves. In an increasingly digital world, some of the large public auto retailers are acquiring dealerships in order to increase their scale. This added demand has boosted the Blue Sky values of dealerships. And while there are plenty of headlines about large deals and high valuations, the environment has persisted because strong earnings have made some dealers reticent to let go of their primary asset during a period of record performance.
The price of a dealership may also be impacted by circumstances unique to the dealer principal. Selling the dealership may mean the loss of a salary in addition to the residual earnings of the dealership. Given the stage of life and other considerations, some dealers may not be willing to give up the golden goose, meaning it would take a much higher price to compensate them to exit the investment, perhaps exceeding the “value” of the dealership.
Price, particularly in the stock market can also be affected by mood, momentum, and sometimes irrational forces. These factors are often referred to as Behavioral Economics. A classic example is “loss aversion” when a person refuses to sell a declining investment to avoid recognizing a loss. In such cases, the person is hoping for a recovery in the price before selling, even if their capital could be better deployed somewhere else. With the GameStop craze last year, plenty of investors piled into the stock wanting to be part of the crowd, being overconfident, or not properly assessing potential risk and return with the investment. While this undoubtedly plays a role in the elevated price, the vast majority of people buying acknowledged the stock price was not in line with the Company’s intrinsic value.
The Value of an Asset or Business
The value of an auto dealership, or any asset, is generally based on its fundamentals. Under an asset approach, the value of an asset is typically based on the condition, age, and creator of that asset. For an auto dealership, the adjusted balance sheet indicates the fair market value of the tangible assets of the dealership. When combined with the Blue Sky value for the franchise rights, the resulting indication represents the total fair market value of the dealership. Under the income approach, the value of the business is determined by three primary factors: earnings/cash flow, risk, and growth. As cash flow/earnings or growth increases, the resulting value increases. As risk decreases, the resulting value will also increase all other things held constant.
While a valuation considers the asset, income, and market approach, the difference between price and value might best be understood through the lens of these approaches. The asset approach is the price of all the Company’s assets, minus the price of its liabilities. The market approach is the price someone else might be willing to pay, based on prices paid for similar dealerships. The income approach however is more of a value perspective. It is based on an expectation of future earnings, weighed against a required rate of return. The value indication is primarily driven by these return expectations, rather than a price an investor would be willing or able to pay.
Price or Value in Auto Dealership Valuations?
After analyzing the differences between price and value, let’s revisit some of the purposes and data points for an auto dealership valuation to determine whether the conclusion represents price or value.
Wealth Transfer/Gift and Estate – VALUE
The valuations of auto dealerships for these purposes are compliance-based and serve to protect the integrity of the transaction or transfer. The valuations are based on the classical valuation models and the conclusions will generally illustrate value.
Valuation for Strategic Planning for Dealer to Contemplate a Sale – PRICE
In this instance, the appraiser might consider specific factors of the investment or buyer in addition to the classical valuation models. The conclusion might consider cost savings to the eventual buyer or improvements that a larger or more sophisticated buyer could implement to improve current operations.
General Litigation or Divorce – VALUE
In the context of most ligation settings, the appraiser is asked to determine the value of the auto dealership for the trier of fact. Likewise, these valuations are based on classical valuation models and the conclusion will generally illustrate value.
Internal Transactions within the Company’s Stock – VALUE and PRICE
In the course of a valuation of an auto dealership, the appraiser will ask management if any recent transactions have occurred in the stock of the Company. Transactions typically consist of an owner buying into the Company or the Company or owner redeeming another owner. These transactions can serve as data points to the valuation. Often, the sophistication and motivation of the buyer and seller are unknown. Further, many of these transactions occur without a formal valuation. In many cases, these transactions will reflect price (how much the buyer can afford to pay) and not necessarily value (what a hypothetical disinterested third party might be willing to pay). Typically, an appraiser would seek to investigate the motivation of the parties and evaluate the conclusion in the context of other classical valuation models to determine if they are an appropriate indication of value.
As we have discussed, price and value are terms that are often used interchangeably. In the context of privately held auto dealerships, the terms can represent different conclusions of value. Some define price as what you pay for an asset, while value is what you receive or what something is worth.
Understanding the purpose for a valuation and the appropriate level of value can dictate whether the conclusion represents price or value. Understanding these terms and the other factors discussed in this post can also explain some of the differences in concluded values for the same auto dealership.
Mercer Capital provides business valuation and financial advisory services, and our auto team helps dealers, their partners, and family members understand the value of their business. Contact a member of the Mercer Capital auto dealer team today to learn more about the value of your dealership.