Four Cornerstones of Value for Business Valuations
My name's Robert Bonavito, New Jersey forensic accountant. This video is part of a series of videos where I discuss forensic accounting topics for educational purposes only.
When we do an appraisal or an evaluation, it's important that we understand the four cornerstones of value. What the four cornerstones of value tells you is whether a company has a strategic advantage or a competitive advantage. And the reason...the only way to really know if a company has a competitive advantage, is look at the profit and loss statement. And you could say that you have a competitive advantage and everybody thinks they have a competitive advantage, but when you look at the profit and loss statement, that tells you if you do have a competitive advantage. And there's only two indications. You need to get higher margins than your competition or lower cost, or both.
So, if someone says they have a competitive advantage but they're not demanding more for their product, they don't have a competitive advantage. Or if their cost is not less than their competition, there's no competitive advantage. It's very easy to tell and it's one of the great things about accounting. Just take a look at the profit and loss. You think Apple has a competitive advantage? Sure, they do. Just take a look at their profit and loss statement. Right? They demand more for their product, and their costs are lower. But, these four cornerstones of value feed into that profit and loss statement and this is what we need to understand when we're evaluating a company.
One, we want to make sure that they exceed their cost of capital. Cost of capital is what the company is paying for the money they borrowed or the money in the company. If they're paying 8%, they should earn 8% or more on their product. You want to make more than it cost you.
Two, you want to have significant cash flows. Some companies have negative cash flow. Well, you can do that for a while. I mean, Amazon did that for a long time. But, eventually, there needs to be positive cash flow. So we look for growing cash flow.
Expectations. Stocks, at least in the public markets, they don't trade on fundamentals, they trade on expectations. What I mean by expectation? Like I said, Amazon before, had negative cash... We would look at that and do an analysis on it for some clients and they had negative cash flows. But yet, the company was valued at $50 billion. Why was our analysis showing that they had negative cash flows and they weren't making money, but yet everybody was buying a stock and bidding it up? Some of it was because these investors were overpaying. But a lot of it was based on expectations. So stocks don't trade on fundamentals, they trade on expectations. And so do private businesses, believe it or not. People overpay for private businesses all the time because they expect it to do something.
And the last one is the best owners. Who owns the business? Okay. Is it the best person to own that business? Sometimes businesses are owned by people who shouldn't own it. They're just not suited for that type of business. So, what we look at is these four areas to determine the value of the company and then we look for a competitive advantage and hopefully we see this in the profit and loss statement. If you have any questions on this video, feel free to give me an email.