9028 / What is the market valuation approach used in valuing closely-held business interests?

The market valuation approach to valuing closely-held business interests attempts to determine the value of stock in a closely-held corporation by comparing it to the price of publicly traded shares in a comparable business. Revenue Ruling 59-60 guidelines (discussed in Q 9027) suggest that comparable business entities in the same or similar line of business must be identified as a starting point in this analysis. Once one or more comparable entities are located, their price/earnings (P/E) ratio must be determined. The P/E ratio is the price per share divided by the earnings of the applicable stock over the most recent 12 month period. This ratio illustrates the investor interest in the stock based on its current selling price on a recognized exchange or on the over-the-counter market.

When evaluating stock of a comparable publicly traded company, it should be remembered that only a small portion of the capital stock issued and outstanding is traded daily. As a result, such trades represent only minority-interest trading. Nevertheless, the P/E ratio of stock in a comparable publicly traded company is relevant because unlike closely-held shares, publicly traded stock has daily marketability through the exchanges, so price is always a known factor.

P/E ratios may fluctuate due to special situations—extraordinary losses or gains may occur in one year or the sale of a subsidiary may cause fluctuations. Moderate P/E fluctuations should be disregarded. However, if a company exhibits wide variations due to extraordinary losses or gains, it may be too volatile to be used as a meaningful basis for comparison.

Marketability Discount