Asset valuation

Abstract

A survey discussing fundamental conceptual issues in valuation. Topics include differences in fundamental valuation, comparative valuation, and replacement-value based valuation; accounting approaches to valuation such as residual income as contrasted with discounted cash flows; the use of valuation ratios based on earnings, dividends, and return on investment; the roles of different types of real capital in valuation depending on whether capital is tangible, intangible, or working capital; and the use of stochastic discount factors in valuation. Various pitfalls leading to common mistakes in valuation are discussed. In addition several applications are presented. Valuation Insight: The survey provides insight into a series of common errors in valuation. These include the inconsistent application of inflation corrections; the impact of predictability in asset prices; the inappropriate adjustment for leverage; incorrect treatment of default risk; insufficient application of the yield curve to account for cash flow duration; and the improper usage of earnings for valuation purposes.