What is an Asset Valuation
Asset valuation is the process of determining the fair market or present value of assets, using book values, absolute valuation models like discounted cash flow analysis, option pricing models or comparables. Such assets include investments in marketable securities such as stocks, bonds and options; tangible assets like buildings and equipment; or intangible assets such as brands, patents and trademarks.
BREAKING DOWN Asset Valuation
Asset valuation plays a key role in finance, and often consists of both subjective and objective measurements. The value of a company’s fixed assets – which are also known as capital assets or property plant and equipment – are easier to value, based on their book values and replacement costs. However, there is no number on the financial statements that tells investors exactly how much a company's brand and intellectual property are really worth. Because the valuation of intangible assets is subjective, there is a risk that goodwill can be overvalued in an acquisition.
Net Asset Value
The net asset value – also known as net tangible assets – is the book value of tangible assets on the balance sheet (their historical cost minus the accumulated depreciation) less intangible assets and liabilities – or the money that would be left over if the company was liquidated. This is the minimum a company is worth and can provide a useful floor for a company’s asset value, because it excludes intangible assets. A stock would be considered undervalued if its market value were below book value, which means the stock is trading at a deep discount to book value per share.
However, the market value for an asset is likely to differ significantly from book value – or shareholders’ equity – which is based on historical cost. And some companies’ greatest value is in their intangible assets, like a biomedical research company.
Absolute Valuation Methods
Absolute value models value assets based only on the characteristics of that asset. These models are known as discounted cash flow (DCF) models, and value assets like stocks, bonds and real estate, based on their future cash flows and the opportunity cost of capital. They include:
- Discounted dividend models, which value a stock's price by discounting predicted dividends to the present value. If the value obtained from the DDM is higher than the current trading price of shares, then the stock is undervalued.
- Discounted free cash flow models calculate the present value of future free cash flow projections, discounted by the weighted average cost of capital.
- Residual income valuation models consider all the cash flows that accrue to the firm post the payment to suppliers and other outside parties. The value of the company is the sum of book value and the present value of expected future residual income. Residual income is calculated as net income less a charge for the cost of capital. The charge is known as the equity charge and is calculated as the value of equity capital multiplied by the cost of equity or the required rate of return on equity. Given the opportunity cost of equity, a company can have positive net income but negative residual income.
- Discounted asset models value a company by calculating the present market value of the assets it owns. As this method does not take into account any synergies, it's only useful for valuing commodity businesses like mining companies.
Relative Valuation & Comparable Transactions
Relative valuation models determine the value based on the observation of market prices of similar assets. For example, one way of determining the value of a property is to compare it with similar properties in the same area. Likewise, investors use the price multiples comparable public companies trade at to get an idea of relative market valuations. Stocks are often valued based on comparable valuation metrics such as price-earnings ratios, price-to-book ratio or the price-to-cash flow ratio.
This method is also used to value illiquid assets like private companies with no market price. Venture capitalists refer to valuing a company's stock before it goes public as pre-money valuation. By looking at the prices paid for similar companies in past transactions, investors can get an indication of an unlisted company's potential value. This is called precedent transaction analysis.