The June 24, 2009 BVWire links to a May 24, 2009 Journal of Accountancy article in which experts note that for publicly traded companies, current market approach-based valuations are below income approach-based ones. This contrasts with the dotcom era, in which the reverse occurred. (Many dotcoms – temporarily – had huge market caps but no revenue, let alone earnings or cash flows.)
In the Market Approach, we know the price of the stock, we forecast cash flows (and growth rates) and then solve for the discount rate (leading to a capitalization multiple). In the Income Approach, we forecast the same cash flows and growth rates, develop a discount rate, and compute a value (stock price). Because the cash flows and growth rates are the same for both approaches (we would otherwise be inconsistent in our assumptions), the value difference between the Market and Income approaches HAS to INVOLVE the discount rate.
Moreover, the Market Approach discount rate is established from the stock price and cash flows, and is not a parameter. This means that the value difference has to do with the Income Approach discount rate. If we use a build-up method (comparing 2007 to 2008, for example) we see that the risk-free rate is lower, the equity risk premium is lower, and the size premium did not change much (for Ibbotson tenth-decile stocks). Of the remaining components, the industry risk premiums are given and not variable (from Ibbotson data). So the only piece that can account for the difference in discount rates and therefore ultimate values is the company-specific equity risk premium. (If you use CAPM, you have to also account for differences in beta, but that would immensely complicate this discussion. I have questions as to the applicability of CAPM to the valuation of small privately held businesses, anyhow.)
This is where the Butler-Pinkerton Model can be helpful, in establishing (higher) floor values for the company-specific risk premium. Whether you use it nor not, review all of the company risk drivers and determine to what extent they have changed: the recession means that there is probably more revenue risk, for one thing, and the credit crunch may also constrain working capital and cash flow.