A rather large topic for one insight but here we go.
With the news that new mortgage rates have risen to 6% the issue of the stress in the bond markets has now hit a topic that all of us can relate to.
The bond markets are not a far distant activity sitting in splendid isolation in the City or Wall Street, as politicians well know. In an indebted economy like most of the first world, the bond markets matter.
But how does this relate to the valuation of mainly private companies, shares and other assets? I am definitely not expert in economic theory, but I am guessing neither are many of our readers. We understand applied economics and how it affects us and our world brilliantly though.
So here’s my simplified valuers guide to why the bond markets matter to us, all day, every day.
Firstly there are the macro issues: politics sways the bond markets and vice versa, whilst the behaviour of both hits valuations in terms of companies’ abilities to borrow (enterprise value vs equity value anyone?), earn interest on savings or debt (impact on pre-tax profits) and of course tax.
Secondly there’s the issue of comparable quoted companies. Large, quoted companies are also subject to their ability to issue bonds and invariably bond yields and returns on equity dance to the music of time in relation to each other. This impacts on share prices and therefore the multiples we frequently use as a starting point for a valuation exercise. An underlying issue cannot be ignored, namely whether the share price of a basket of stocks fully encompasses the macro issues facing the industry and arguably therefore the company subject to valuation (ignoring fundamentals).
Lastly there is the impact on the risk free rate which, is a key input in determining the cost of capital for DCFs and other sophisticated valuation methodologies such as Monte Carlo simulations and the Black Scholes Option Pricing Model.
You can see why our team are avid readers of the business press and the markets.
Of course, there are numerous ways to value a company and unquoted comparable transaction multiples, NAV adjusted valuations or balance scorecard approaches do not immediately draw the mind towards the bond market, but nonetheless it would be unsafe to ignore the issue of its volatility. Possibly tiny start-ups or very simple “high street” businesses are less sensitive. But you never know – after all a single-shop high street estate agent could still be affected if mortgage rates rise, leading to a slowdown in house buying and selling activity.
Whether you have what appears to be the most straightforward valuation for a “vanilla” situation or something highly technical and complex from a valuation perspective we would be delighted to assist you and your client.
