Definition and example for system evaluation

What is asset valuation?

The valuation of assets is the process of determining the fair market or present value of assets using book values, absolute valuation models such as discounted cash flow analysis, option pricing models or comparative values. These assets include investments in marketable securities such as stocks, bonds and options; Physical assets such as buildings and equipment; or intangible assets such as brands, patents and trademarks.

Understand asset valuation

Valuation of assets plays a key role in finance and often consists of subjective and objective measurements. The value of a company’s fixed assets – also known as fixed assets or tangible assets – can be easily assessed using the book values ​​and replacement costs. However, there are no numbers in the financial statements that tell investors exactly how much a company’s brand and intellectual property are worth. Companies can overestimate goodwill in an acquisition because the valuation of intangible assets can be subjective and difficult to measure.

Net asset value

Net asset value – also known as net property, plant and equipment – is the book value of property, plant and equipment on the balance sheet (their cost less accumulated depreciation) less intangible assets and liabilities – or the money that would be left if the company were to liquidate. This is the minimum value a company is worth and can be a useful lower bound on a company’s asset as it does not take intangible assets into account. A stock would be considered undervalued if its market value is below book value, which means that the stock is trading at a steep discount to book value per share.

However, the fair value of an asset is likely to differ materially from its book value – or equity – based on historical cost. And the greatest value of some companies lies in their intangible assets, such as the results of a biomedical research company.

Absolute valuation methods

Absolute value models only value assets based on the properties of that asset. These models are known as discounted cash flow (DCF) models and value assets such as stocks, bonds, and real estate based on their future cash flows and the opportunity cost of capital. They include:

• Discounted dividend models that value the price of a stock by discounting forecast dividends to present value. If the value obtained from the DDM is higher than the current market price of the stock, the stock is undervalued.
• Discounted free cash flow models calculate the present value of future free cash flow forecasts, discounted with the weighted average cost of capital.
• Residual income valuation models take into account all cash flows that the company receives after payment to suppliers and other external parties. The enterprise value is the sum of the book value and the present value of the expected future residual income. Remaining income is calculated as net income minus a charge for the cost of capital. The fee is known as the equity fee and is calculated by multiplying the value of equity by the cost of equity or the required 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 value of the assets it owns. Since this method does not take synergies into account, it is only useful for evaluating raw material companies such as mining companies.

Relative valuation & comparable transactions

Relative valuation models determine value by observing the market prices of similar assets. For example, one way to determine the value of a property is to compare it to similar properties in the same area. Investors also use the price multiples at which comparable listed companies are traded to get an idea of ​​the relative market valuations. Stocks are often valued using comparable valuation metrics such as the price / earnings ratio (P / E), the price / book value ratio or the price / cash flow ratio.

This method is also used to value illiquid assets such as private companies with no market price. Venture capitalists refer to the valuation of a company’s stock before it goes public as a pre-money valuation. By looking at the amounts paid in previous transactions for similar companies, investors can get an indication of the potential value of an unlisted company. This is known as precedent analysis.

Real example of asset valuation

Let’s calculate the net asset value of Alphabet Inc. (Demokratie), the parent company of search engine and advertising giant Google.

All figures relate to the period up to December 31, 2018.

• Balance sheet total: $ 232.8 billion
• Total intangible assets: $ 2.2 billion
• Total liabilities: $ 55.2 billion

Total net asset value: $ 175.4 billion (Total assets $ 232.8 billion – total intangible assets $ 2.2 billion – total liabilities $ 55.2 billion)