Valuation is estimating an asset's value based on factors that could impact future returns. There are several types of value:
1. Intrinsic value is the theoretically perfect value based on full knowledge of investment characteristics. Market price may differ from intrinsic value, allowing for mispricing.
2. Going-concern value assumes the company continues as is. Liquidation value is what the company is worth if dissolved.
3. Investment analysts use valuation for stock selection, inferring market expectations, and evaluating corporate events like mergers. The valuation process involves understanding the business, forecasting performance, selecting a model, and applying the valuation conclusion.
Valuation is estimating an asset's value based on factors that could impact future returns. There are several types of value:
1. Intrinsic value is the theoretically perfect value based on full knowledge of investment characteristics. Market price may differ from intrinsic value, allowing for mispricing.
2. Going-concern value assumes the company continues as is. Liquidation value is what the company is worth if dissolved.
3. Investment analysts use valuation for stock selection, inferring market expectations, and evaluating corporate events like mergers. The valuation process involves understanding the business, forecasting performance, selecting a model, and applying the valuation conclusion.
Valuation is estimating an asset's value based on factors that could impact future returns. There are several types of value:
1. Intrinsic value is the theoretically perfect value based on full knowledge of investment characteristics. Market price may differ from intrinsic value, allowing for mispricing.
2. Going-concern value assumes the company continues as is. Liquidation value is what the company is worth if dissolved.
3. Investment analysts use valuation for stock selection, inferring market expectations, and evaluating corporate events like mergers. The valuation process involves understanding the business, forecasting performance, selecting a model, and applying the valuation conclusion.
Valuation is estimating an asset's value based on factors that could impact future returns. There are several types of value:
1. Intrinsic value is the theoretically perfect value based on full knowledge of investment characteristics. Market price may differ from intrinsic value, allowing for mispricing.
2. Going-concern value assumes the company continues as is. Liquidation value is what the company is worth if dissolved.
3. Investment analysts use valuation for stock selection, inferring market expectations, and evaluating corporate events like mergers. The valuation process involves understanding the business, forecasting performance, selecting a model, and applying the valuation conclusion.
What Is Value? What is the value of a particular asset? The answers to this question usually influence success or failure in achieving investment objectives. For one group of those participants—equity analysts—the question and its potential answers are particularly critical, because determining the value of an ownership stake is at the heart of their professional activities and decisions. Valuation is the estimation of an asset’s value based on variables perceived to be related to future investment returns, on comparisons with similar assets, or, when relevant, on estimates of immediate liquidation proceeds. Intrinsic Value The intrinsic value of any asset is the value of the asset given a hypothetically complete understanding of the asset’s investment characteristics. For any particular investor, an estimate of intrinsic value reflects his or her view of the ―true‖ or ―real‖ value of an asset. If one assumed that the market price of an equity security perfectly reflected its intrinsic value, ―valuation‖ would simply require looking at the market price. The rational efficient markets formulation recognizes that investors will not rationally incur the expenses of gathering information unless they expect to be rewarded by higher gross returns compared with the free alternative of accepting the market price. the levels of market efficiency in different markets or tiers of markets affect the market price (for example, stocks heavily followed by analysts and stocks neglected by analysts). Overall, equity valuation, when applied to market-traded securities, admits the possibility of mispricing. Throughout these readings, then, we distinguish between the market price, P, and the intrinsic value (―value‖ for short), V. Mispricing equity valuation, when applied to market-traded securities, admits the possibility of mispricing. Throughout these readings, then, we distinguish between the market price, P, and the intrinsic value (―value‖ for short), V.
Perceived mispricing is a difference between the estimated intrinsic value
and the market price of an asset. To obtain a useful estimate of intrinsic value, an analyst must combine accurate forecasts with an appropriate valuation model. The quality of the analyst’s forecasts, in particular the expectational inputs used in valuation models, is a key element in determining investment success. For active security selection to be consistently successful, the manager’s expectations must differ from consensus expectations and be, on average, correct as well. Going-Concern Value A company generally has one value if it is to be immediately dissolved and another value if it will continue in operation. In estimating value, a going-concern assumption is the assumption that the company will continue its business activities into the foreseeable future. In other words, the company will continue to produce and sell its goods and services, use its assets in a value-maximizing way for a relevant economic time frame, and access its optimal sources of financing. The going-concern value of a company is its value under a going-concern assumption. Liquidation value a going-concern assumption may not be appropriate for a company in financial distress. An alternative to a company’s going-concern value is its value if it were dissolved and its assets sold individually, known as its liquidation value. For many companies, the value added by assets working together and by human capital applied to managing those assets makes estimated going-concern value greater than liquidation value (although a persistently unprofitable business may be worth more ―dead‖ than ―alive‖). Fair market value Fair market value is the price at which an asset (or liability) would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell. Furthermore, the concept of fair market value generally includes an assumption that both buyer and seller are informed of all material aspects of the underlying investment. Fair market value has often been used in valuation related to assessing taxes. Investment value
Assuming the marketplace has confidence that the
company’s management is acting in the owners’ best interests, market prices should tend, in the long run, to reflect fair market value. In some situations, however, an asset is worth more to a particular buyer (e.g., because of potential operating synergies). The concept of value to a specific buyer taking account of potential synergies and based on the investor’s requirements and expectations is called investment value Applications of Equity Valuation Investment analysts work in a wide variety of organizations and positions; as a result, they apply the tools of equity valuation to address a range of practical problems. In particular, analysts use valuation concepts and models to accomplish the following: Selecting stocks. Stock selection is the primary use of the tools presented in these readings. Equity analysts continually address the same question for every common stock that is either a current or prospective portfolio holding, or for every stock that he or she is responsible for covering: Is this security fairly priced, overpriced, or under-priced relative to its current estimated intrinsic value and relative to the prices of comparable securities? Applications of Equity Valuation Inferring (extracting) market expectations. Market prices reflect the expectations of investors about the future performance of companies. Analysts may ask: What expectations about a company’s future performance are consistent with the current market price for that company’s stock? What assumptions about the company’s fundamentals would justify the current price? (Fundamentals are characteristics of a company related to profitability, financial strength, or risk.) Applications of Equity Valuation Evaluating corporate events. Investment bankers, corporate analysts, and investment analysts use valuation tools to assess the impact of such corporate events as mergers, acquisitions, divestitures, spin-offs, and going private transactions. A merger is the general term for the combination of two companies. An acquisition is also a combination of two companies, with one of the companies identified as the acquirer, the other the acquired. In a divestiture, a company sells some major component of its business. In a spin-off, the company separates one of its component businesses and transfers the ownership of the separated business to its shareholders. A leveraged buyout is an acquisition involving significant leverage [i.e., debt], which is often collateralized by the assets of the company being acquired.) Applications of Equity Valuation
Rendering fairness opinions. The parties to a merger may be required to
seek a fairness opinion on the terms of the merger from a third party, such as an investment bank. Valuation is central to such opinions. Evaluating business strategies and models. Companies concerned with maximizing shareholder value evaluate the effect of alternative strategies on share value. Communicating with analysts and shareholders. Valuation concepts facilitate communication and discussion among company management, shareholders, and analysts on a range of corporate issues affecting company value. Applications of Equity Valuation Appraising private businesses. Valuation of the equity of private businesses is important for transactional purposes (e.g., acquisitions of such companies or buy–sell agreements for the transfer of equity interests among owners when one of them dies or retires) and tax reporting purposes (e.g., for the taxation of estates) among others. The absence of a market price imparts distinctive characteristics to such valuations, although the fundamental models are shared with public equity valuation. An analyst encounters these characteristics when evaluating initial public offerings. for example, An initial public offering (IPO) is the initial issuance of common stock registered for public trading by a company whose shares were not formerly publicly traded, either because it was formerly privately owned or government-owned, or because it is a newly formed entity. Applications of Equity Valuation Share-based payment (compensation). Share-based payments (e.g., restricted stock grants) are sometimes part of executive compensation. Estimation of their value frequently depends on using equity valuation tools. The Valuation Process In general, the valuation process involves the following five steps: 1. Understanding the business. Industry and competitive analysis, together with an analysis of financial statements and other company disclosures, provides a basis for forecasting company performance. 2. Forecasting company performance. Forecasts of sales, earnings, dividends, and financial position (pro forma analysis) provide the inputs for most valuation models. 3. Selecting the appropriate valuation model. Depending on the characteristics of the company and the context of valuation, some valuation models may be more appropriate than others. The Valuation Process
4. Converting forecasts to a valuation. Beyond mechanically obtaining the
―output‖ of valuation models, estimating value involves judgment. 5. Applying the valuation conclusions. Depending on the purpose, an analyst may use the valuation conclusions to make an investment recommendation about a particular stock, provide an opinion about the price of a transaction, or evaluate the economic merits of a potential strategic investment.