Value in the eye of the beholder: a survey of valuation practices of Estonian financial professionals

Mark Kantaukov,Priit Sander

doi:10.21511/imfi.13(2-1).2016.04

Mark Kantaukov, Priit Sander

Open Access

https://doi.org/10.21511/imfi.13(2-1).2016.04

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Abstract

This is the first empirical study related to the linkage between distributed profit taxation and company valuation. In this paper we present the results of a survey of Estonian valuation practitioners. The main purpose of this study is to clarify the valuation practices of Estonian analysts with emphasis on fundamental analysis-based valuation methods. We elucidate whether and how practitioners treat certain aspects of corporate income taxation when valuing Estonian companies, and how they adjust conventional models taking into account the peculiarities of the Estonian distributed profit taxation system. As distributed profit taxation allows Estonian companies to postpone their income tax liability, it should lead to a positive impact on the value of Estonian companies compared to non-Estonian ones. The survey also included hypothetical valuation cases seeking to determine the difference in analysts’ views on equity value in a simplified framework. Results show that free cash flow to the firm and EV/EBITDA multiples are the most popular valuation models among analysts, with the majority of analysts using these models together. Analysts adjust models primarily when calculating the cost of capital and forecasting corporate income tax liability. However, many respondents did not make any adjustments when valuing Estonian companies, but proceeded from the same grounds when valuing Estonian and non-Estonian businesses. The equity valuation of hypothetical companies revealed highly diverse estimates and an unawareness of the positive aspects of distributed profit taxation vis-à-vis traditional profit taxation on a company’s value

Highlights

Results show that free cash flow to the firm and EV/EBITDA multiples are the most popular valuation models among analysts, with the majority of analysts using these models together
Our findings indicate that the dividend discount model is rarely used by Estonian analysts, this is a must-know for any valuation practitioner
As the majority of Estonian companies are privately held we focused entirely on fundamental analysis-based methods

Summary

Introduction

Results show that free cash flow to the firm and EV/EBITDA multiples are the most popular valuation models among analysts, with the majority of analysts using these models together. Markets for other securities are underdeveloped: e.g. bond market capitalization was 82.78 m EUR as of the end of 2015, and there are no Estonian government bonds on the market This raises several issues when deriving valuation inputs, such as risk-free rate. Under Estonian corporate income taxation system, companies do not have to pay corporate income tax on retained earnings; income tax is imposed only on distributed profits which include dividends, share buybacks, share capital reduction, and fringe benefits (Income Tax Act of Estonia, § 50). In Estonia the statutory income tax rate has fallen since the adoption of the DPT system from 26% in 2000 to 20% in 2015 (which is the current rate) These circumstances imply that such enterprises should be more valuable to an investor vis-à-vis peers operating under the traditional profit taxation regime and theoretically should be valued higher

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Conclusion