Valuation Overview

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CHAPTER 1

INTRODUCTION TO VALUATION

Every asset, financial as well as real, has a value. The key to successfully investing

in and managing these assets lies in understanding not only what the value is but also the

sources of the value. Any asset can be valued, but some assets are easier to value than

others and the details of valuation will vary from case to case. Thus, the valuation of a

share of a real estate property will require different information and follow a different

format than the valuation of a publicly traded stock. What is surprising, however, is not

the differences in valuation techniques across assets, but the degree of similarity in basic

principles. There is undeniably uncertainty associated with valuation. Often that

uncertainty comes from the asset being valued, though the valuation model may add to

that uncertainty.

This chapter lays out a philosophical basis for valuation, together with a

discussion of how valuation is or can be used in a variety of frameworks, from portfolio

management to corporate finance.

A philosophical basis for valuation

It was Oscar Wilde who described a cynic as one who “knows the price of

everything, but the value of nothing”. He could very well have been describing some

equity research analysts and many investors, a surprising number of whom subscribe to

the 'bigger fool' theory of investing, which argues that the value of an asset is irrelevant as

long as there is a 'bigger fool' willing to buy the asset from them. While this may provide a

basis for some profits, it is a dangerous game to play, since there is no guarantee that such

an investor will still be around when the time to sell comes.

A postulate of sound investing is that an investor does not pay more for an asset

than its worth. This statement may seem logical and obvious, but it is forgotten and

rediscovered at some time in every generation and in every market. There are those who

are disingenuous enough to argue that value...