No single method values an asset. Over the years, researchers and practitioners have built a number of them, each approaching the same question from a different angle, and we’ve gathered a selection here for anyone who wants to learn how they work.
Two evaluations of the same exact asset can carry different values. This separation is due to the evaluator’s choice of techniques used and the lens they chose to look through.
An evaluation rarely leans on a single technique as it usually takes a combination of multiple to reach an estimate. And evaluators don’t all reach for the same ones. Some techniques are quantitative where parameters go in, a figure comes out, and the same inputs always reach the same answer. Others are qualitative as they are built to catch the real condition of the asset, how deep its market actually runs and what numeric inputs can’t explain. An evaluator may blend both or simply favour one over the other. But what matters most is the judgement they bring to it. In the end, a technique only offers a general estimate for that class of asset, and the role of the evaluator is to apply their experience and judgement to bend that estimate until it fits the specificity of the asset being valued.
Which one fits depends on the asset, on what evidence actually exists for it, and on what the number has to survive once someone challenges it.
A free cash flow to the firm projection table is built from a set of assumptions based on the budgeting of the company and is then discounted to the present value at the weighted average cost of capital. Resulting in the value of the business as a whole.
A similar technique to the Discounted Cash Flow approach in the addition of including any new borrowing. That cash flow is discounted at the cost of equity, which gives the value of the equity directly.
A share is valued at the present value of the dividends it is expected to pay. The model is simple, but it undervalues companies that pay out less than they can afford and keep the rest.
The evaluator first values the business as if it were financed entirely by equity. The present value of the tax savings on its debt is then added, and the expected cost of financial distress is subtracted. This keeps the effect of the financing separate from the value of the operations.
The value is the capital already invested plus the present value of future excess returns. Each year’s excess return is the return on capital minus the cost of capital, multiplied by the capital invested. A business only adds value when it has a surplus of return on capital against its cost of capital.
The business is valued at the equity on its balance sheet, which is the assets at historical cost less depreciation, minus the liabilities. This method however can sit far from market value, because it ignores what the assets could earn or sell for today.
The assets are valued at what they would fetch if sold off one by one, under different scenario assumptions. The liabilities that must be paid to creditors are then deducted from the proceeds.
The assets are valued at what it would cost to replace them today. The ratio of market value to replacement cost is called Tobin’s q. Above 1, investors are paying more than the assets would cost to replace. Below 1, they are paying less.
The evaluator takes a standardised earning ratio, such as enterprise value to EBITDA or price to earnings, from comparable companies or transactions. The multiple is adjusted for differences in growth and risk, then applied to the target’s own figure to estimate its fair value.
The evaluator uses option pricing models to value assets whose payoff depends on a future decision, such as a patent, an undeveloped oil reserve or the right to expand. These models capture the value of being able to wait and act if conditions turn favourable.
An evaluator picks the method, does the research, and shows the working.