You've stopped the car on a foggy evening. Your headlights don't illuminate much -- just a road that, according to your trusty folding map, doesn't belong there. The compass says north is where you think east ought to be. As for the GPS, it's just beeping.

That, more or less, is the situation faced by anyone trying to value a company in the past 10 months or so. The three basic yardsticks dealmakers and investors have developed for the purpose -- comparisons with public company stock prices, comparisons with relevant transactions and a discounted cash flow analysis of the company itself -- aren't working well. Complementary and relatively straightforward in less turbulent times, the tools became contradictory and hard to apply in the midst of the financial crisis.

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Out of kilter
True value
In the thick of it

The result is a valuation disconnect more severe than any we've seen in decades, a fitting if disorienting element of this unusually severe recession. At once a cause and an effect, a risk and an opportunity, the disconnect helps account for many signs of the times, from a surge in goodwill write-downs by public companies in the fourth quarter of 2008 and the first quarter of 2009 to a rise in unsolicited bids to the greater difficulty companies face when they try to restructure or exit bankruptcy.

Is the disconnect temporary? Or does it signal fundamental change -- a reset, where industries are radically re-evaluated, price-earnings ratios for stocks find new norms and corporate acquirers adjust their expectations for growth and rate of return? The challenge of answering that question is one reason dealmaking has slowed so much. "People talk about a first-mover disadvantage," says Oliver Maier, U.S. vice president for M&A and business development in the Americas for Evonik Industries AG, a German specialty chemicals company with more than $20 billion in sales.

Even so, Evonik bought a specialty chemicals company for around $100 million in Europe in November, and Maier is at work on several potential transactions in the U.S. Other corporate dealmakers, consultants and investment bankers are getting on with valuation tasks, too. And by looking over their shoulders as they try to apply the three familiar yardsticks, it's possible to answer some smaller questions that shed some light on the big ones.

Inevitably, the discussion starts with financing, or the lack of it. Maybe it's just capitalist karma that uncertainty over the value of complex financial assets has created uncertainty over the value of nearly everything else. When panic about all those suddenly mysterious assets on their books caused banks to stop lending last fall, we were reminded that assumptions about credit are woven into business plans and valuation judgements throughout the economy. And, needless to say, throughout the stock market. Most stock prices anticipate growth, after all, and most growth requires financing. The idea that financing could no longer be taken for granted by even the best companies was a major factor in the plunge in stock prices. "The lack of capital really depressed growth expectations," says Gary Frantzen, Chicago-based senior vice president at American Appraisal Associates Inc. "Last October you could have had a cure for cancer and you couldn't get it funded."

The anomalies produced by the sharp decline in stock prices are the inverse of those seen in the dot-com bubble, observes Jerry Mehm, San Francisco-based senior vice president at American Appraisal. Ten years ago, he saw faddish Web companies trading far above the value a discounted cash-flow analysis would assign to them. Now he's seeing good industrial firms, able to grow at 5%, trading far below a DCF-generated valuation.

This time, however, the anomalies are more widespread and, according to one industrial-company dealmaker, harder to correct for. This dealmaker notes that his own company's stock is down about 40%, at least twice what would be warranted by the falloff in business it has suffered. So when he looks at another company where the stock is down about 40%, can he assume that investors have overshot by a similar amount? When the market is painting with such a broad brush, it's hard to be sure. "Maybe the market undershot," he says, "and they're even worse off than they look today."

For many companies, the share price has also dipped low enough to set off an important alarm. "When book values are quite different than what the stock price is saying," says Stamos Nicholas, a principal with Deloitte Financial Advisory Services, "someone -- auditors, lenders, shareholders -- is going to start asking questions about what's real."

When that happens, of course, it's time to inspect for goodwill impairment. Valuation consultants have seen plenty of such work in recent months, says Bryan Browning, Milwaukee-based senior vice president at Valuation Research Corp. The charges against earnings that can result, many of which have run into the billions, are never pleasant. Especially unsettling for corporate dealmakers, though, have been the charges associated with recent acquisitions -- for example, Rite Aid Corp.'s write-down of $1.2 billion in goodwill related to its 2007 acquisition of part of the Brooks Eckerd chain.

Another consequence of the stock market's plunge, says Anthony Aaron, a principal in the valuation practice in Ernst & Young LLP, is an increase in the proportion of hostile bids. In early May, FactSet MergerMetrics reported that 30% of all offers involving U.S. public companies this year have been unsolicited or hostile. No great surprise there, but it's useful to remember that what a hostile bid usually boils down to is an argument over valuation. "When you look at people's belief about what their companies are worth and where they're priced in the marketplace, there's such a schism these days," Aaron says.

Because of that schism, arguments are breaking out all over. PepsiCo. Inc.'s pursuit of its two main bottling units and Broadcom Corp.'s proposed takeover of Emulex Corp. are two current examples. All three targets accuse the bidders of trying to take advantage of unusually depressed stock prices.

Along with better days in the stock market, sellers seeking to defend their desired prices also like to hark back to palmier times in M&A. But for buyers, the yardstick of comparable transactions has a couple of major flaws these days. One is simply that the low number of transactions getting done under current market conditions makes it hard to find a recent comparable.

s for valuations in past transactions, well, they got a little skewed. How relevant, for example, is a financial sponsor's take-private from three years ago, done at 12 times Ebitda and 8 times leverage, which now happens to be in bankruptcy? "We're going to discount that or maybe discard it," says Andrew Stull, a managing director at Houlihan, Lokey, Howard & Zukin Inc. who advises on valuation issues from the firm's Atlanta office. "We're much more discriminating about which comparables we put weight on."

With both kinds of comparables compromised, all these practitioners say, people are relying even more heavily on the third yardstick, always the most important one, anyway. In the current uncertain climate, however, doing a discounted cash-flow analysis poses its own set of problems. The good news is that it's company-specific, making market noise much less of a problem. The bad news is that it requires valuers to make some predictions about the company itself, about its industry and about the broader economy, all at a time when the future is especially hard to envision.

The company itself may be tougher to gauge for several reasons. A dealmaker helping to move his industrial company into services, for example, faces challenges evaluating talent at a time when businesses are stalled, or pulling back. "Everyone is running scared, so it's difficult to figure out who the really high performers are," he says. In restructuring situations, meanwhile, the capital structures can be more challenging than they were in the last down cycle, according to Houlihan's Stull. "You have first lien, second lien, and you have unsecured debt," he says.

ndustry projections involve many more unknowns. Some may be regulatory, as financial services dealmakers well know. And the prospect of major rule changes is also making it harder to estimate future cash flows in parts of healthcare. "Without clarity on reimbursement rates and payment methodology changes, valuations are contracting, and deals appear to be sidelined," says Gary Sheehan, CEO of Cape Medical Supply Inc. in Sandwich, Mass.

Then there are the future commercial fortunes of the industry to think about. The headlines about those sectors turn out to be just a starting point. Yes, automotive looks bleak, housing gloomy, retail iffy and pharma fairly healthy. But if the target makes a material used in auto windshields and people start keeping their cars for 10 years, maybe the replacement business is going to expand.

Recessions tend to accelerate change within industries. Middlemen get squeezed, the weak fall by the wayside, stronger business models come to the fore. All this makes the winners and losers -- not to mention their cash flows -- harder to predict. Valuers must think more in terms of probabilities and scenarios. Underlying everything else is an unusually cloudy macroeconomic outlook and, for many companies, a vulnerability to spikes in commodity prices, so volatile in recent years. Says Ernst & Young's Aaron: "Sometimes the best advice we can give our clients is 'if this kind of future happens, this is what the value might be.' "

When several plausible scenarios exist, it's easy to guess which ones the buyer and the seller will gravitate toward. The natural divergence is not a formula for smooth negotiations. "In today's markets, we're at a point where you can't get buyers and sellers to agree on what a reasonable set of projections is. They look at the world very differently," says Bruce Altman, New York-based managing director at KPMG Corporate Finance LLC.

So what are the dynamics of dealmaking under such conditions? Inevitably, there's a lot more erring on the side of caution. But there are also a few difference-spanning and risk-management tools that come into play more often.

"What we do even less now is chase deals," says the industrial company dealmaker. "We won't adjust our valuation based upon 'we're close, we'll try to get this done.' The number is what the number is." This dealmaker says he is also turning more often to outside advisers for confirmation that the number is what the number ought to be. "While the overall volume of deals is down," he says, "the percentage of deals where we would look to have another party helping us out with this has gone up."

Since risks are higher, acquirers demand that the potential rewards be greater as well. The new balance is especially clear in the few private equity deals getting done. "Our required return and the required return of every other PE player has shifted northward materially," says Nicole Arnabaldi, chairman of the DLJ Merchant Banking Partners unit at Credit Suisse Group. "I don't think people are doing deals where they don't think the returns are at least 30%, and that's with very conservative assumptions about economic growth, leverage available, pricing of leverage and exit options."

At Evonik, Oliver Maier says the challenge of bridging valuation gaps has led him to include an earnout component in some bids. Making part of the purchase price contingent on future developments is a familiar -- if not especially beloved -- practice for dealmakers buying venture-backed companies, where a technology may or may not pan out or catch on, and also in biotech deals, for similar reasons. What's unusual here is using earnouts to bridge a disagreement over the value of a company that now has little or no cash flow but whose owner believes it can get back to levels of profitability it enjoyed in the recent past. Maier says he favors an earnout period of perhaps 18 months in such deals.

The dealmaking toolkit is large and contains many devices that come in handy when conditions are unstable. When acquirers pay in stock, for example, people know how to stabilize the currency. "Puts and collars are being used to be sure the downside is minimized," says Deloitte's Nicholas.

But there's no device that can answer the really important question, which is how long the uncertainty will last -- and what the world will look like when the fog finally lifts.

Evonik's Maier expresses a view many share.

"I think we'll come out at a much lower, more conservative place," he says. "A lot of the price inflation had obviously to do with private equity and hedge funds being successful. And that model is crippled to a degree. I think we'll come out at a lower baseline."

Given recent signs that the economy may at least be stabilizing, perhaps we'll even start to see that baseline come into view by the end of the year.

For that to happen, though, dealmaking volume must pick up -- and the three yardsticks will have to start looking more consistent with each other.