Asset valuation for investors: What it is and how it works
Key Takeaways
- Asset valuation is a procedure aimed at determining the right value of a specific asset.
- Scrutinized assets can be both tangible and intangible.
- Asset valuation, which can be subjective, can help investors understand if the market price of the asset is fair, or if the asset is over/undervalued, which may potentially identify a dislocation and thus an investment opportunity.
Machinery, real estate, stocks, options, bonds and even the goodwill of an organization all have a value that can be defined using different mechanisms.
Asset valuation can be required when a company is a target acquisition, for instance, or for insurance purposes.
Tangible vs Intangible Assets
Items such as structures, land, vehicles, and certificates of investment in marketable securities, as well as office equipment and cash on hand, are considered tangible assets (these are also referred to as fixed assets.) Intangible assets are logos, trademarks, franchise agreements, reputation, and intellectual property – such as patents and copyright.
Intangible assets valuation can pose problems as it can be subjective, but existing models can help get around the issue. Intellectual property can fluctuate – if, for instance, a patent gets closer to expiration. Typically, however, valuations are conducted by professionals who have tested methods for both tangible and intangible assets, which may mitigate outcome volatility.
A company’s goodwill in a merger or acquisition transaction can be particularly hard to measure, and it is usually determined “a contrario” as a plug between the price that the acquiring company is paying and the target company’s current equity valuation.
Why Asset Valuation Matters
In the event of a merger or a takeover, asset valuation can help determine the overall value of a business. For investors, especially in private equity, it can help determine whether the asked-for price for shares in a company is in line with the company’s actual value.
Collateralized loan applications normally require asset valuation for the asset that is intended to be used as collateral to help the lender ensure that its investment is sufficiently protected. For publicly traded companies, assets on the balance sheets may require valuations to comply with transparency regulations. Asset valuation and depreciation come into play when calculating tax liability as well.
The book value of the tangible assets listed on a balance sheet is calculated based on the acquisition cost of an asset, less its accumulated depreciation.
Tangible Asset Valuation
The three leading valuation methods for fixed/tangible assets include the cost method, the market value method and the value-based method.
Under the cost method, the purchase price of the asset is listed as its value. The market value method looks at what the item would bring if it were offered for sale on the open market. The value-based method affixes a value to an asset based upon its capability to generate revenue. This can be a function of the net present value of future cash inflows, or the cash that would be generated by selling it.
Depreciation is another factor in the determination of tangible asset valuation. After all, wear, tear, and obsolescence can decrease the value of a tangible asset over time. The value of an asset when depreciation is taken into consideration becomes its net value.
Depreciation can be calculated by several different methods. Two of the most common are the straight-line depreciation and declining balance methodologies.
Intangible Asset Valuation
The value of intellectual property can be significant, yet quantification can be challenging. The three primary methods applied to this task are the market approach, income approach and cost approach.
Under the market approach, comparable prices paid for similar assets are considered. The income approach bases the value of the asset on the present value of its perceived future income. The cost approach is predicated upon an estimate of the cost of developing a similar intangible asset.
Asset Valuation and Alternative Investments
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