Valuation Concern : On Going & Liquidation

Valuation has been a really important parameter to arrive at the conclusion if any security/company is selling for cheap in the open market or not. But the decision about how to arrive at valuation is a pretty important matter as well.

There are two ways of Valuing a Company , i.e is the company to be valued as a Going Concern or Liquidation Basis ? 

The reason why we mention Going Concern and Liquidation decides how does one value a business. One may ask what difference is there , and why such a difference in terms of valuation for business.The answer lies in the fact about capitalism, and the constant and dynamic change in business environment where either new industries are introduced from nowhere ( e.g -technology), or the destruction of other industries ( due to many reasons , outsourcing, technological change has made the industry obsolete,smaller commodity companies cannot keep up with changing business environment). 

While many industries do not face the problem of obsolesce due to the products they offer (e.g chewing gum industry, food industry (taste might change),shaving industry,soft drink), certainly a few do.For the former class measuring the companies by their earnings or as a going concern is a much better yardstick for valuation , and for the latter a liquidation valuation does make a lot more sense. 

That said, there are times when one can find companies valued fairly on an earnings or a going concern, but substantially cheap on a liquidation basis. While one might guess that the best way to make money would be to just liquidate the business , the other reason for such undervaluation is that assets operating or non operating are carried on the Balance Sheet at Historical Cost which happens to be really low, and now predictive of what it would be in today's market. 

If the asset is non-operating we have two businesses combined in one entity, one is an ongoing business while the other a non-operating business which can be sold and a one time substantial gain can be realized by the shareholders.

If the asset is operating, and sells for relatively cheap much more care and attention should be put on the earnings and the Return on Assets (ROA) and Return on Equity (ROE) should be considered accordingly as this might result into higher ROA & ROE with comparable business, and a false undervaluation for the same.

So it is really necessary and important to know what the business is and what part of the growth cycle( either be mature or declining as well) it operates into to decide what valuation methodology to be used.