One of my valuation mentors taught me early on to periodically reread Revenue Ruling 59-60 with a fresh pair of eyes. (In my case, this requires reading glasses.)
I think this particularly important to do in these financially perilous times, and just did so. I was very interested in what 59-60 had to say about periods in which financial markets are not functioning normally. As I write this, the IPO market is closed tight, bank credit is exceptionally stringent, the Dow is down 44% from its preceding 52-week high, investment banks are history, other financial institutions are on their knees, and so forth … clearly a period of abnormality!
I thought that perhaps 59-60, with its emphasis on hypothetical buyers and sellers willing and able to trade, acting rationally, and sufficiently informed, might instruct us to look beyond such abnormalities and assume something along the lines of “markets functioning normally” (those are my words, not 59-60’s).
Wrong!
Right in the introductory paragraph, 59-60 tells us to consider “all relevant factors”. I think the above abnormalities are highly relevant to current valuations, both in terms of what is known and what is not known (e.g. statistics on how badly the economy has declined and how rates of return we commonly rely upon have changed). There is specific mention of how general economic conditions vary from normal to boom to depression times, and to the impact of investor expectations (optimism or pessimism). There is also reference to current conditions of active, free[ly trading] public markets, and to [case-]specific circumstances. Finally, there is the fundamental exhortation to use “common sense, informed judgment, and reasonableness”.
Take a few minutes and reread 59-60. You will always learn something new, as do I.