What is a Market Approach
A market approach is a method of determining the appraisal value of an asset, based on the selling price of similar items. The market approach is a business valuation method that can be used to calculate the value of property or as part of the valuation process for a closely held business. Additionally, the market approach can be used to determine the value of a business ownership interest, security, or intangible asset. Regardless of which asset is being valued, the market approach studies recent sales of similar assets, making adjustments for differences in size, quantity or quality.
BREAKING DOWN Market Approach
While it can be relatively simple to value publicly traded companies, based on their stock price at any given moment, less than 1% of all companies in the United States are publicly traded. This presents challenges for those trying to obtain a fair price for an asset or company that is privately held. Two major types of market approaches to valuation are: the Guideline Transaction Method (using prices of similar companies recently sold) and the Guideline Public Company Method (using prices of similar companies publicly traded).
Examples of the Market Approach
In the real estate industry, a property's value can often be estimated by looking at comparables, such as recent property sales, similar in size and features, located in close proximity to the property being valued. With companies, steps investors often take to value private business include sourcing recent transactions (sales, mergers), close in operations, industry, and economic conditions.
An example would be trying to derive the value of a young cybersecurity company. An analyst might scan recent cybersecurity companies that have gone public, noting if the private and newly IPO-ed firm target the same customer base, have similar revenues, and rely on analogous processes for keeping their customers safe.
The Market Approach: Areas of Potential Concern
Areas that investors and analysts should pay close attention to when taking the market approach include sales or revenues figures. Two companies may both be in the healthcare industry; however, if one is a large pharma firm and the other a small-cap biotechnology company, comparing transactions involving them could not be fully relevant. It is also crucial to apply correct pricing multiples during the valuation process. For example, a TTM (trailing twelve months) enterprise value multiple should not be applied when considering a NTM (next twelve months) projection of a company being valued.