Asset-Based Valuation Models | CFA Level I Equity Investments

We are on to the last valuation model – the asset-based valuation model.

Understanding Asset-Based Valuation Models

The concept of asset-based valuation models is actually very simple. The analyst estimates the fair value of all the assets of the firm, and the fair value of all the firm’s liabilities. The intrinsic value of the common stock is therefore the total value of the assets, minus all liabilities, and minus the value of the firm’s preferred stock. Express this on a per share basis, and that is the intrinsic price of each share.

So, for example:

• Fair value of all assets: $3 million
• Fair value of all debt: $1.6 million
• Preferred stock value: $0.5 million
• Firm’s common stock value: $3 – $1.6 – $0.5 = $0.9 million
• Outstanding shares: 20,000
• Intrinsic value per share: $0.9M / 20,000 = $45

If the current stock price is higher than this, it is overvalued based on this method, and undervalued if the stock price is lower than $45.

Challenges in Asset-Based Valuation Models

And that’s where the simplicity ends. The difficulty of such an approach lies with valuing the fair values of the assets and liabilities. For most companies, balance sheet values can be quite different from fair values. However, an analyst may be able to reasonably value the assets and liabilities by starting with balance sheet items. Possible approaches can be to calculate depreciated values, inflation-adjusted depreciated values, or estimated replacement values.

Do bear in mind some of the issues the analyst may face when using such an approach:

1. Assets like plant, property, and equipment can be difficult to value. This is because specific information about these assets may not be made publicly available, and the values of these assets can be very subjective.
2. Intangibles are another problem area. Some intangible assets like goodwill and copyrights are recorded on the balance sheet, while others like brand value, reputation, and customer loyalty are not. Regardless, the effect of most intangibles is difficult to quantify, so some analysts may choose to exclude them altogether.

In such a case, this type of approach can give a “floor” value for the stock – that is, stripping out all the intangibles, the company’s stock is worth at least this amount. For a company that has significant intangibles, the analyst should consider supplementing this value with a more forward-looking valuation, such as one from a present value model.

Using Asset-Based Valuation Models

So as you can see, the asset-based valuation model can present challenges when most public companies are still not reporting the fair values of their assets. This is the reason why this model is often a last resort for many analysts when no other valuation method is appropriate. This may change, though, as public companies increase reporting or disclosure of fair values.

In practice, asset-based valuation models are more often used together with multiplier models to value private companies. This is because analysts can demand more detailed information about the company’s assets in order to arrive at a fair value of the fair value of the individual assets held by the company.

Conclusion

And that concludes this lesson on asset-based valuation models. In our final lesson next, we wrap up with a comparison of the various valuation models we have learned.