What is valuation?
This blog is designed to provide students of FINC3015 (Course Description - potential students, or even just people interested in valuation) with some useful material beyond that provided during the course of the semester. In other words, its a semi-intellectual forum aimed at addressing issues in valuation. This blog is periodically updated so stay on board for the ride.
As an opening post, i'd like to address a number of simple, yet necessary questions about valuation analysis. The three questions below are a starting point for anyone that is thinking about undertaking a course in valuation or anyone that is looking at investing (whether it be in stocks, property, or in a small business).
To begin, i'd like to address the question, what is valuation?
Valuation is a fundamental concept aimed at directing capital allocation decisions. To put it simply, how things are valued will affect how we employ resources. While this sounds a little technical, it makes a lot of intuitive sense, because if asset A and B both cost the same amount and asset B returns 12% while asset A only return 5%, then it is unlikely that we are going to put money towards buying asset A (assuming all else is the same).
Similarly, an individual who is looking to purchase an investment property, is primarily concerned about the yield he or she is going to get and therefore the capital that they commit to a property is defined by their valuation of that property. This example raises a number of very important concepts.
1. The return on an investment is a function not only of the quality of the asset but how much is paid for the asset.
2. Valuation analysis is a personal thing (not in a sentimental way). For example, what return would you be happy with? 1, 2, 5, 10, 20%? Before you make a mistake and answer this question, let me throw in a second dimension that you should always couple with this question. What is the risk associated with that return? This is the number one finance lesson that i hope is learned before people leave university. You could possibly throw in a third dimension, which is was is risk profile of the investor, however, this is largely an extension of the previous point.
3. Since valuation is a personal thing, no two valuations will ever be the same. If i grow up on the beach, irrespective of how many valuations i perform i will somehow find a way to add some premium to houses that are located nearby. Someone from the bush, however, not holding the same satisfaction for the waterfront views will not.
But before you conclude that valuation is simply a collective opinion of peoples views about what something should be worth, lets stop for a second to analyse this statement. When was the last time analysts from UBS, Macquarie, Deutsche etc... told you that RIO was a buy at $100? Not that long ago. You often hear the phrase, an asset is worth what people are willing to purchase it at. But is it really? If i bought Macquarie Group for $99 when it was trading at its high - is what i'm holding onto a $100 stock? Yes, no, maybe - the answer could be any of the three.
The point that i am trying to make here is simple: value gets confused. Value, as it is taught in basic corporate finance is the sum of future expected cash flows. Somewhere along the line, people tend to forget this and valuations begin to go awry. The difficult part of this statement is the expectation surrounding those cash flows. This will generate the majority of discussion for most analysts. Value (from an investment perspective) should never be accepted because the market tells you it is value. What i mean by this is that you should never just buy a stock because its share price goes up. Valuation analysis is about providing you with a set of skills, not to become a millionaire (although we'll still keep trying) but rather to avoid making the bad decisions.
I'll address the following questions (as well as other valuation issues) in subsequent posts.
As an opening post, i'd like to address a number of simple, yet necessary questions about valuation analysis. The three questions below are a starting point for anyone that is thinking about undertaking a course in valuation or anyone that is looking at investing (whether it be in stocks, property, or in a small business).
To begin, i'd like to address the question, what is valuation?
Valuation is a fundamental concept aimed at directing capital allocation decisions. To put it simply, how things are valued will affect how we employ resources. While this sounds a little technical, it makes a lot of intuitive sense, because if asset A and B both cost the same amount and asset B returns 12% while asset A only return 5%, then it is unlikely that we are going to put money towards buying asset A (assuming all else is the same).
Similarly, an individual who is looking to purchase an investment property, is primarily concerned about the yield he or she is going to get and therefore the capital that they commit to a property is defined by their valuation of that property. This example raises a number of very important concepts.
1. The return on an investment is a function not only of the quality of the asset but how much is paid for the asset.
2. Valuation analysis is a personal thing (not in a sentimental way). For example, what return would you be happy with? 1, 2, 5, 10, 20%? Before you make a mistake and answer this question, let me throw in a second dimension that you should always couple with this question. What is the risk associated with that return? This is the number one finance lesson that i hope is learned before people leave university. You could possibly throw in a third dimension, which is was is risk profile of the investor, however, this is largely an extension of the previous point.
3. Since valuation is a personal thing, no two valuations will ever be the same. If i grow up on the beach, irrespective of how many valuations i perform i will somehow find a way to add some premium to houses that are located nearby. Someone from the bush, however, not holding the same satisfaction for the waterfront views will not.
But before you conclude that valuation is simply a collective opinion of peoples views about what something should be worth, lets stop for a second to analyse this statement. When was the last time analysts from UBS, Macquarie, Deutsche etc... told you that RIO was a buy at $100? Not that long ago. You often hear the phrase, an asset is worth what people are willing to purchase it at. But is it really? If i bought Macquarie Group for $99 when it was trading at its high - is what i'm holding onto a $100 stock? Yes, no, maybe - the answer could be any of the three.
The point that i am trying to make here is simple: value gets confused. Value, as it is taught in basic corporate finance is the sum of future expected cash flows. Somewhere along the line, people tend to forget this and valuations begin to go awry. The difficult part of this statement is the expectation surrounding those cash flows. This will generate the majority of discussion for most analysts. Value (from an investment perspective) should never be accepted because the market tells you it is value. What i mean by this is that you should never just buy a stock because its share price goes up. Valuation analysis is about providing you with a set of skills, not to become a millionaire (although we'll still keep trying) but rather to avoid making the bad decisions.
2) Who does valuation analysis?
3) What competitive edge do you get from performing valuation analysis?
I'll address the following questions (as well as other valuation issues) in subsequent posts.
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