In the last 10 years, the term ‘valuations’ has become synonymous with fame and fortune.
Unknowingly, we all use valuations on a day-to-day basis to debate assets and investments. But how know what something is worth?
How would you wish to be ready to value anything or maybe unique assets like an airport, or a hotel, or a collector car, or a business? Or more important question – does one asset have one value? Can one asset have multiple values?
One object multiple views.
For instance, look at this object (we need to identify an honest object here, sort of a cup, or a car that is around). One object that has multiple views counting on your point of view or perspective. Similarly, one asset can have multiple valuations.
If you think about a house that is up for sale…it may have four data points of value…
- Asking price
- Zestimate (or an algorithm-generated value)
- Assessed value
- Closing price
In a perfect world, they ought to be the same, but they are doing not need to be.
So, the same object has different views depending on your vantage point. Similarly, a business or an asset can have multiple valuations – might be for tax, or insurance, or transaction, or accounting.
Now that we understand that one asset can have multiple valuations – allow us to discuss how valuations work?
I am close to offering you the building blocks of the way to value anything. I have been lucky to value several of the foremost unique assets within the world. A few them include –
- The Atlanta Airport
- The Mirage Casino Las Vegas
- The Aleyaskan Pipeline
- The Golden Gate
- The Brooklyn Bridge
The State of Hawaii to call a couple of. How did I do it? How do you value a bridge? Or an airport? Or one among the fastest-growing taxi or hotel companies within the world?
It is simple. Follow the money….
There are only 3 ways to value anything –
- Economic Benefit Analysis – also called the income approach – basically, you are valuing the cash flow from the asset
- Market Comparables – or market approach – here you are looking for what other similar assets are trading for in the open market and equating that value to your asset
- Cost Approach – or asset approach – what would it cost to recreate or build that asset
Economic Benefit analysis is simple. You consider the cash flow benefits the asset provides, divided by the cost to own that asset. V=B/C
In such cases, B is generally measured in money or some form of an economic benefit.
And C is measured in the cost of capital to own or reap benefits from the asset. Also sometimes known as the cap rate or the WACC or the discount rate.
As the benefit of ownership increases, and the cost of ownership decreases, the value increases.
This approach is most effective when the asset to be valued has quantifiable benefits. Example cash flow, or royalties, or annuity, or rent, etc.
The Market Approach. This method of valuation is used for assets when one can find comparable assets to do an apple to apple analysis.
For example – houses, or similar real estate assets. Or companies that have similar companies to compare them to. Or fine arts or antiques that have comparables to consider.
In this approach, you look for an asset that is most like your subject.
For example – for discussion purposes, if you are looking to value a 2000 square foot house. You would look for a house that is identical to your subject. Same square footage, yard, neighborhood, etc. If you are unable to find an identical comparable, you lower your expectations by finding the most similar comparable. And in an ideal world, the value of the most similar comparable you could find would be the value of the house in consideration.
And last the cost approach. This approach comes into play when the other two approaches do not work or are not applicable. Perhaps you cannot find a comparable. It may be a unique asset like the Brooklyn Bridge. Or perhaps it is not easy to estimate economic benefits from it. How would you estimate all the economic benefits of the Atlanta Hartsfield Airport?
In such cases, use a cost approach. This approach estimates the cost of replacement (could be reproduction also in some cases) of the asset. What would it take to rebuild or recreate an asset with comparable functionality?
The best valuations use a combination of the above three approaches. Or at the very least consider all of them in their analysis.