What’s it: Asset valuation is the process of determining the present value of a company’s assets, such as stocks, fixed assets, and intangible assets. It is useful for several decisions, such as buying and selling company shares, acquisitions, and asset insurance.
Asset-based valuation allows you to calculate a company’s net worth by adding its assets’ present value minus the value of its liabilities.
The benefits of asset valuation
An accurate valuation of the value of the company’s assets is an essential input in making decisions, such as:
- Determine the price of the target company in an acquisition. Thus, the acquirer buys at the right price.
- Buy or sell company stock. Analysts use a fundamental approach to determine the company’s shares’ fair price, which is useful for making buying or selling decisions.
- Calculate taxation. The company owns various properties, such as production facilities. And, valuation helps calculate taxes for such assets.
- Apply for loans or insure assets. Valuation is useful for determining the right premium. Likewise, banks will usually evaluate the value of assets that become loan collateral.
Fixed asset valuation
To value fixed assets, you can use various alternative methods, including:
- The cost method. This method determines fixed assets based on the purchase price of the asset.
- Market value method. In this case, the asset’s value is based on the market price or the projected price if it is sold on the open market.
- Value-based method. This method values an asset based on its capacity to generate cash. You measure it by calculating the net present value of future cash inflows or cash generated by selling assets.
The economic value of fixed assets decreases in value over time due to wear and tear factors. Therefore, the measurement also adjusts for the decline in value of the asset (depreciation) over time. Specifically, when reporting it in the financial statements, the company presents it as net value, i.e., gross fixed assets minus accumulated depreciation.
There are various methods of calculating depreciation. Two of them are the straight-line method and the declining balance method.
Intangible asset valuation
Intangible assets are one of the sources of a company’s competitive advantage. But, unlike fixed assets, they have a subtle substance. Thus, they are more challenging to quantify. A common way to value an intangible asset is to use:
- Market approach: based on market evidence of what third parties have paid for comparable intangible assets.
- Income approach: assuming that an asset’s value is the present value of the asset’s future income.
- Cost approach: based on the estimated cost of building or acquiring new intangible assets that are roughly the same as existing ones.
Some often used models to determine the value (price) of a company’s shares are discounted dividend models, discounted free cash flow models, and comparable valuation.
- Discounted dividend model. Under this approach, you calculate the stock price by discounting the future dividend to its present value.
- Discounted cash flow model. You determine the stock price from the present value of the projected future free cash flows. Your first task is to make a free cash flow projection for the next few years (usually five years). You then discount it using the weighted average cost of capital (WACC).
- Comparable valuation. To determine the stock price, you use the valuation ratios of several peer companies. The often-used ratios are the price-to-earnings ratio (P / E ratio), price-to-book ratio (P / BV ratio), or price-to-cash flow ratio.