Tariffs and fair value: A comparative framework for fund valuations

The IPEV Special Guidance (March 2020), issued during the COVID-19 pandemic, remains highly relevant in this case. It emphasises that fair value should reflect an orderly transaction, not a distressed or fire-sale price, and that valuation inputs must be adjusted carefully to avoid ‘double dipping’ risk adjustments in both earnings and discount rates. These principles are critical when navigating the valuation complexities introduced by tariff shocks.

Tariff shock: Structural impacts on valuation models

Tariff regimes—especially those introduced abruptly or with geopolitical undertones—create valuation challenges that differ fundamentally from systemic financial or health crises.

Key impacts on valuation:

• Cost structure volatility: Tariffs alter input costs unpredictably, invalidating historical margins and rendering trailing performance unreliable.
• Pricing distortion: Market comparable companies may no longer reflect true economic value due to policy-induced price shifts.
• Discount rate calibration: Tariff uncertainty inflates risk premiums, complicating the estimation of future cash flows and cost of capital.
• Levelling shift: Observable inputs (Level 1 or 2) may become unavailable or irrelevant, pushing valuations into Level 3, requiring greater reliance on judgment and disclosure.
• Impairment risk: Tariff exposure may trigger asset impairment reviews under IAS 36, especially for capital-intensive or export-dependent businesses.

Forecasting weaknesses in tariff-driven valuations

Forecasting is central to fair value modelling, particularly for DCF. Tariff shocks introduce unique distortions that undermine the reliability of forward-looking estimates:

Key challenges

• Cost volatility: Tariffs can change input costs overnight, making historical margins obsolete.
• FX risk: Currency fluctuations driven by trade retaliation distort cross-border revenue and cost projections.
• Demand elasticity: Tariff-induced price increases reduce demand in unpredictable ways.
• Policy uncertainty: Future tariff regimes are politically driven and difficult to model.
• Supply chain reconfiguration: Firms may reroute trade through third countries, invalidating prior assumptions.
• Managerial bias: Forecasts may be influenced by internal optimism or defensive positioning.
• Earnings manipulation: Firms may adjust guidance to manage investor expectations amid uncertainty.

Valuation guidance under ASC 820, IFRS 13, and IPEV

In tariff-heavy environments, valuation professionals must adapt their methodology to reflect market realities and regulatory expectations.

Recommended approaches:

• Market-based multiples: Use EV/EBITDA and EV/sales based on LTM data, as NTM forecasts are often unavailable or unreliable. We note that:
  • While NTM projections typically reflect expected growth under normal market conditions, they are inherently more subjective during periods of economic uncertainty or sector-specific headwinds (e.g., tariff disruptions). In such cases, forward-looking estimates may lack the prudence and verifiability required for defensible valuation, especially during the periods of structural evolution.
  • LTM figures—whether audited or unaudited—offer a more grounded basis for valuation. Moreover, market multiples as of the valuation date already embed participants’ expectations of future growth. These multiples implicitly adjust for forward-looking sentiment, thereby allowing LTM-based valuation to reflect a fair and market-aligned value without introducing excessive subjectivity.

• Discount rate adjustments: Incorporate FX risk, policy uncertainty, and supply chain volatility into risk premiums.
• Scenario modelling: Apply multiple tariff scenarios with sensitivity analysis to capture the valuation range.
• Enhanced disclosure: Clearly document assumptions, input sources, and rationale for Level 3 classifications.
• Impairment testing: Evaluate recoverability of asset values, especially for inventory-heavy or export-dependent businesses.

What to avoid:

• Blind reliance on historical margins or growth rates
• Ignoring geopolitical developments in valuation assumptions
• Using single-point forecasts without probabilistic modelling
• Adjusting valuations based on hindsight, which is prohibited under IFRS 13

Conclusion: Tariffs as a valuation disruptor

Tariff shocks represent a policy-induced valuation disruption, distinct from the systemic collapse of the GFC or the exogenous nature of COVID-19. They uniquely distort cost structures, competitive positioning, and market observability, often without the liquidity support or fiscal backstops seen in prior crises.

While undertaking valuations, it is prudent to prioritise market-based inputs over intrinsic models and enhance disclosure rigour to reflect uncertainty.

This is the first article in the series on best practices and their impact on the fair value framework for emerging market-focused funds.

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