Valuation Analysis
Candlefocus EditorThe goal of valuation analysis is to consider the risks involved in each asset class, and attempt quantify those risks in terms of their impact on the value of the asset. Common forms of valuation include methods such as discounted cash flow (DCF), comparable company analysis, and the cost approach. In each of these valuation techniques, the fair market value of an asset is derived by analyzing a cash flow projections for the asset, the current market value of similar assets, and the cost of replicating the asset.
DCF Analysis is typically used as the most reliable method of valuation as it considers multiple variables and factors such as return on capital invested, economic climate, inflation rate etc. This form of analysis uses the cash flows from each asset over a certain period of time in order to calculate what the asset’s value is today. Comparable company analysis is another form of valuation used, whereby the market value of a similar company is used to derive the value of the company in question. This method helps investors analyze the relative returns on similar assets. Lastly, the cost approach of valuation is used less frequently now due to the advent of more quantitative forms of valuation. This approach includes valuing an asset based on the sum of its individual parts, such as the land and building, machinery, patents, and other components that make up the asset.
Valuation analysis helps investors assess the true value of an asset in order to make informed decisions. Without accurate and comprehensive valuations, investors may purchase assets at an unjustifiably high or low price. Valuation also helps investors compare multiple investments to determine which ones are likely to generate the highest returns. Thus, proper valuation analysis is essential to ensure that investors are making sound and informed decisions.