Fall 2014 issue of Horizons

CONSTRUCTION

Valuation Strategies for Construction Companies by Tim Farquhar, CFA, CPA

T he valuation methodologies described on pages 15-18 can be applied to companies in the construction industry. However, typical companies in the construction sector exhibit much greater volatility in operating performance than companies in general, and as a result, it can be much harder to predict future performance. Because of these differences, the approaches discussed on pages 15-18 will be slightly different for construction-related companies, as described over the following pages. Income Approach A discounted cash flow, as described on page 16, is not as useful or commonplace in construction valuation. The construction industry is very sensitive to the prevailing

interest rate environment and the business cycle and tends to experience more frequent and more volatile boom and bust periods than the economy as a whole. Because of these unique aspects of the construction industry, it is very difficult to predict financial performance more than one year into the future. Therefore, when applying an income approach to a construction-related company, RubinBrown generally uses an income capitalization method rather than a discounted cash flow.

The income capitalization method involves two variables:

∙ Income or cash flow stream to be capitalized

∙ Capitalization rate that is used to convert the cash flow stream to a value

page 34 | horizons Fall 2014