What do you mean by an emerging market?
While the term “emerging market” is often used as a shorthand way to refer to countries that are entering a phase of significant economic growth, from a financial valuation perspective the concept of an emerging market is often not so straightforward.
Types of emerging market
- Country that is undergoing a phase of rapid economic growth.
- Market which is the result of the combination of two markets.
- Emerging market is a sub-market in an economically mature market.
What are the valuation challenges in an emerging market?
As per the top financial advisory firms, from market-based as well as cash flow-based valuation approach, valuing companies in emerging markets presents significant challenges.
- Cash flow-based valuation approaches:
To forecast the company’s future cash flow is the common way for company to be valued. But the challenge is there may be not enough transactions history to extract a discount factor. More importantly, emerging markets often experience high degrees of volatility and accordingly cash flows and risk levels can be highly susceptible to change, either moving to more stability, lower risk and lower growth rates or becoming significantly riskier and at times even collapsing.
- Market-driven valuation approaches:
Another common way for the companies to be valued is to derive metrics from the market. These metrics usually does not exist because in emerging markets there can be very little transaction history of company type or assets type.
Emerging Market Valuation Principles
To face the challenges of emerging market valuation, it is helpful to keep the following points in mind:
Definition of market: The first thing is to correctly define the market that the company is in. company in a highly volatile emerging market may actually have a business model, like a company in an emerging market whose sales are based on long-term contracts with highly stable buyers.
Use of other markets as valuation reference points:
Different markets have different realities, like many business models are structurally similar even if they located in different jurisdictions. This can help define income and cost structures and profitability.
Once this is done, it is then necessary to compare the company to be valued with companies in the reference market to see whether the reference valuation parameters should be adjusted upwards or downwards. Some key factors to consider in this comparative analysis are:
- The profitability of the company to be valued compared with companies in the valuation reference group;
- Risks to the company’s current revenue and cost structure compared with risks that affect the company’s valuation reference group;
- Ability of a company to take advantage of that growth market compared with companies in the valuation reference group, based on such factors as strength of the companies’ leadership and management teams, the nature of competitors in the market, barriers to market entry and regulatory factors that promote or restrict competition.
According to Top financial advisory firms it is possible to obtain a valuation of a company or asset in an emerging market that is fair for investors as well as target companies.