VALUATION THEORY
Chepakovich Valuation Model Valuation Basics Valuation of Banks Intrinsic Value
VALUATION BASICS
What is Value?
What is the value of something? There is no single answer to this question. Even from the point of view of purely utilitarian usefulness (i.e. disregarding any emotional, symbolic, historical or other value), what is dear to someone could be absolutely worthless to somebody else. However, even the most worthless (from an individual's point of view) thing has a value as long as there is someone who is willing to pay for it.
Thus, we come to our general definition of economic value: Value is the highest price the product or service can fetch at a specific time, place and circumstances. As emphasized in this definition, the notion of value is not universal - it has meaning only if applied to very specific conditions that describe the scope of product's availability and usefulness. Value is also temporal - it is very time specific and can change in an instance.
Even in its economic sense, value is pretty much a philosophical concept not yielding itself easily to quantification. Numerical estimation of value does not come from inherent characteristics of the product - it comes from without, from what potential users of the product are willing to pay for it.
Value of Financial Instruments
Unlike other products, most financial instruments convert into money at a predefined time in the future and, therefore, their value can be quite easily calculated based on specific assumptions about risk and time value of money. In such cases value can be called intrinsic value, as it is determined by future cash flows endemic to the financial instrument.
One of notable exceptions to this is common stocks. A common stock represents ownership in a corporation, rather than a claim on a predefined future cash flow. Therefore, for stocks (unlike most other financial instruments) the intrinsic value concept has very limited applicability and can also be misleading. It should only be used with an understanding that it is nothing more than oversimplification of the actual nature of this financial instrument. In essence, a stock is represented as a perpetual bond whose coupon payments are equal to dividends or cash flow to equity (depending on what valuation methodology is used).
Though quite limited in its practical applicability, particularly over short periods of time (it works much better long term), the intrinsic valuation approach still serves as a reliable and objective guide to investors. In our opinion, it is the best stock selection technique for long-term investors.