Valuation techniques for companies in IT sector

Abstract

The purpose of this project is to try out some of the valuation techniques for valuation of companies in the IT sector. In the IT sector companies in the three segments viz. Software services, Software Products and Hardware are valued as part of this project. The three approaches used for valuation are discounted cash flow, residual income and valuation using multiples. From the analysis of the three valuation approaches used for assessing the value of a company it becomes clear that the approach of using multiples is quite susceptible to giving erroneous results. But it is a fairly straightforward method to get a ballpark figure for a companies share price and value. Using DCF for company valuation is a much better approach, provided one has insight into the various line items of the financial statements and their co-relations from a business perspective. EVA provides an idea of the value that a company is generating for the investments being done by it. The analysis also reveals absence of debt from the financial statements particularly long term debt for the IT companies. This can be attributed to the fact that IT companies are not resource intensive. So generally they won t have physical assets to offer as collateral to banks and other creditors. Because of this fact the companies are mostly equity financed and consequently, the WACC is fairly high. The financial statements analysis also brings out the fact that it is generally the product companies that invest lot more in R and D. Software Services companies tend to have relatively less spending on Plant and machinery.