Notes on valuation

In this Financial Times article (paywall), the opinion writer made a number of good points about the art of valuation. Many of these are wise words that even experienced fundamental stock investors should re-read once in a while, just to remind themselves of some of the basics.

Valuation is sometimes more art than science and there are many, many ways to calculate the value of an asset. This depends on the imagination and interpretation of the user and also in my view, the objective of the person doing the valuation.

To a dividend investor, the reliability of the cashflow and payouts may be more important than the leverage ratio. To a bank lending money, the leverage, loan terms, interest coverage may be more important. This is not to say that they do not look at other metrics, but certain numbers carry more weight with certain users.

Due to this subjectivity, there is a lot of room to "fudge" the numbers when using different methods to value something. Even if you are honest with yourself, different methods come with their own pros and cons. To avoid this, one should use a number of methods to derive different estimates of the value and sniff out the true (or close to true) value of the asset. Even then, the best you can come up with is a range of values, and not a single "accurate" number. For there is no such thing.

Another important point to note is that the value you put on the asset is not the same as what the market prices it at (assuming there is a liquid market at all). He used examples of stock frauds that crashed to zero, or how the Instagram purchase by Facebook was panned but turned out to be correct (an opinion he held in his former life as a fund manager). So the wisdom of crowds may not produce an accurate valuation.

The last and most salient point, to me at least, is that if we are to buy assets, we should have a way to value them. This doesn't apply just to trading or investing however. If a bank lends money to a counterparty, for example, the bank needs to value the collateral put up by the borrower.

This last point was illustrated by the author using the ongoing lawsuit against Donald Trump. You might be lost as to which lawsuit as there are many, it's the one the New York Attorney General brought against him, his two sons and the Trump Organization for fraud.

In this document, we can see examples of when the values of some properties provided by the defendants were wildly inflated.

Trump Tower Triplex