What Is Valuation Analysis?
Let me tell you directly: valuation analysis is the process I use to estimate the approximate value or worth of an asset, whether it's a business, equity, fixed income security, commodity, real estate, or something else. As an analyst, I might apply different approaches depending on the asset type, but the core idea remains examining the underlying fundamentals of that asset.
Key Takeaways
- Valuation analysis seeks to estimate the fair value or intrinsic value of an asset, such as a business or a security.
- Valuation analysis relies on several different methodologies and models in order to come up with a single price based on different inputs or variables.
- 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.
Understanding Valuation Analysis
You should know that valuation analysis is mostly science, involving number crunching, but there's also a bit of art because I have to make assumptions for the model inputs. The value of an asset boils down to the present value of all future cash flows it's expected to produce. When I build a model for a company, for instance, it includes a bunch of assumptions about sales growth, margins, financing choices, capital expenditures, tax rates, and the discount rate for the present value formula.
Once I've set up the model, I can adjust the variables to see how the valuation shifts with different assumptions. There's no universal model that fits all asset classes. For a manufacturing company, a multi-year discounted cash flow model might work well, while for a real estate firm, I'd use current net operating income and capitalization rate. Commodities like iron ore, copper, or silver? Those get modeled around global supply and demand forecasts.
How Valuation Analysis is Used
The results from valuation analysis can appear in various forms. It might be a single number, like saying a company is worth about $5 billion, or a range if the asset's value depends on a fluctuating variable—think a corporate bond with high duration valued between par and 90% of par based on the 30-year Treasury yield. I can express valuation as a price multiple too, such as a tech stock at 40x price-to-earnings, a telecom at 6x enterprise value to EBITDA, or a bank at 1.3x price-to-book. Sometimes it comes out as asset value per share or net asset value per share.
Valuation and Intrinsic Value
Valuation analysis matters for investors like you because it helps estimate the intrinsic values of company shares, leading to better investment decisions. For bonds, fair values usually stick close to intrinsic values, but opportunities pop up during financial stress for heavily indebted companies. This analysis is a solid tool for comparing companies in the same sector or figuring out potential returns on an investment over time.
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