Valuation Analysis
What Is Valuation Analysis?
Valuation analysis is a process to estimate the approximate value or worth of an asset, whether its a business, equity, fixed income security, commodity, real estate, or other assets. The analyst might use different approaches to valuation analysis for different types of assets, but the common thread will be checking out at the underlying fundamentals of the asset.
Understanding Valuation Analysis
Valuation analysis is generally science (number crunching), but there is likewise a bit of art involved because the analyst is forced to make assumptions for model inputs. The value of an asset is basically the present value (PV) of all future cash flows that the asset is forecasted to produce. Inherent in the estimation model for a company, for example, is a horde of assumptions regarding sales growth, edges, financing choices, capital expenditures, tax rates, discount rate for the PV formula, etc.
Once the model is set up, the analyst can play with the variables to see how valuation changes with these different assumptions. There is nobody size-fits-all model for assorted asset classes. Whereas a valuation for a manufacturing company might be amenable to a long term DCF model, and a real estate company would be best modeled with current net operating income (NOI) and capitalization rate (cap rate), commodities like iron ore, copper, or silver would be subject to a model centered around global supply and demand forecasts.
How Valuation Analysis is Used
The output of valuation analysis can take many forms. It tends to be a single number, for example, a company having a valuation of approximately $5 billion, or it very well may be a range of numbers on the off chance that the value of an asset is largely dependent on a variable that often fluctuates, for example, a corporate bond with a high duration having a valuation range between par and 90% of par depending on the yield on the 30-year Treasury bond. Valuation can be expressed as a price multiple. For example, as a tech stock is trading at a price-to-earnings (P/E) multiple of 40x, a telecom stock is valued at 6x enterprise value- to-earnings before interest, taxes, depreciation and amortization (EV/EBITDA) or a bank is trading at 1.3x price-to-book (P/B) ratio. Valuation analysis can likewise take the last form of as asset value per share or net asset value (NAV) per share.
Valuation and Intrinsic Value
Valuation analysis is important for investors to estimate intrinsic values of company shares to make better-informed investment decisions. Fair values of bonds don't deviate a lot, if by any stretch of the imagination, from intrinsic values, but opportunities really do arise once in a while on account of financial stress of a heavily indebted company. Valuation analysis is a useful tool for comparing companies inside the same sector or estimating a return on an investment over a given time period.
Highlights
- Valuation analysis seeks to estimate the fair value or intrinsic value of an asset, like business or a security.
- Different valuation processes will be employed depending on the type of asset being considered, whether that asset produces cash flows, and what the purpose of the valuation is for.
- Valuation analysis relies on several different methodologies and models to come up with a single price based on different inputs or variables.
