What is 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.
Importance of Understanding Asset Valuation
Asset valuation plays a crucial role in finance, consisting of both subjective and objective measurements. The value of a company’s fixed assets—known as capital assets or property plant and equipment—is relatively easy to calculate based on their book values and replacement costs. Companies utilize asset valuation when applying for loans, while banks review it during credit assessments.
However, financial statements often lack clear indicators of a company’s brand or intellectual property value. The subjective nature of valuating intangible assets means companies may overvalue goodwill during acquisitions.
Key Insights:
- Asset valuation is the process of determining an asset’s fair market value.
- It involves both subjective and objective measurements.
- Net asset value is essentially the book value of tangible assets minus intangible assets and liabilities.
- Absolute value models evaluate assets based solely on their characteristics.
- Relative valuation ratios help investors compare similar assets.
Calculating Net Asset Value
Net asset value (NAV), also known as net tangible assets, represents the book value of tangible assets (their historical cost minus accumulated depreciation) minus intangible assets and liabilities. This gives the minimum value of a company, excluding intangible assets. A stock trading below this figure suggests undervaluation, trading at a deep discount to book value per share.
It should be noted that market value and book value may vary significantly. Some companies’ greatest strengths lie in their intangible assets, e.g., intellectual property of a tech firm.
Methods for Absolute Valuation
Absolute value models focus on valuating assets solely based on their characteristics. Known as discounted cash flow (DCF) models, these methods assess stocks, bonds, and real estate based on future cash flows and opportunity cost of capital. They include:
- Discounted dividend models: Value a stock by discounting predicted dividends to their present value, identifying undervalued stocks.
- Discounted free cash flow models: Calculate present value of projected future cash flows, adjusted by the weighted average cost of capital.
- Residual income valuation models: Consider post-payment to suppliers and outside parties, combining book value and expected future residual income.
- Discounted asset models: Determine the value based on the present value of owned assets, often used in commodity businesses like mining.
The Power of Relative Valuation & Comparable Transactions
Relative valuation models estimate the value of an asset by comparing it with similar assets. For instance, property valuation often involves comparing similar properties in the same area. Investors use price multiples from comparable public companies to gauge relative market values. Common valuation metrics include the price-to-earnings ratio (P/E), price-to-book ratio, and price-to-cash flow ratio.
These methods are also useful for valuing illiquid assets, such as private companies. By looking at past transaction amounts for similar companies, investors can estimate an unlisted company’s value—known as precedent transaction analysis.
Real-World Application: Asset Valuation for Alphabet Inc.
Let’s calculate the net asset value for Alphabet Inc., the parent company of Google, using figures from Dec. 31, 2018:
- Total assets: $232.8 billion
- Total intangible assets: $2.2 billion
- Total liabilities: $55.2 billion
Conclusion
Understanding asset valuation can demystify financial statements and offer critical insights into true asset worth. Utilize absolute and relative valuation methods to make informed investment decisions, checking market prices, book values, and considering intangibles’ value ahead of every financial move.
Related Terms: Book Value, Present Value, Tangible Assets, Capital Assets.
