Any stock valuation approach that is asset-based involves adjusting the value of both assets and liabilities to arrive at the current value and facilitate the calculation of a proper net asset value. This adjustment can be carried out by taking each individual item separately or considering all the assets and liabilities in a collective manner. Because it takes special skills to value assets like items of plant and machinery or real estate, it often requires the services of outside valuation experts. On the other hand, collective valuation is far easier as it is a single calculation. It is generally carried out by establishing the value for the collective assets and liabilities over the book value and establishing a price-to-book multiple.
No matter what form of asset-based valuation you use, the valuation is dependent on the benefits that they owners can expect to derive in the future. This would in turn depend upon the future income that these assets can generate or what they would fetch if they are liquidated or sold. Which of these would apply depends on the particular circumstances at that point in time. There are too many variations on asset-based valuation techniques. You could carry out your valuation based on liquidation value which is what the assets would fetch if they were sold on the open market. Alternatively, you could use a replacement value approach where you can calculate what it costs to establish these assets at current prices.
The ultimate objective of any asset-based valuation attempts to place a fair value on the assets and the differences in the approaches only center around the way values are assigned. For instance, if you are looking at a liquidation-based approach, you will attempt to place a value on the assets depending on what prices similar assets are selling at on the market. On the other hand, in traditional discounted cash flow valuation, you are attempting to establish the future income generating potential of these assets. In certain circumstances, both these approaches can result in similar values.
Asset-based valuation is often considered appropriate when you are looking for a controlling interest in a company. This is because the controlling interest gives you complete control of the underlying assets and you have the freedom to sell off unproductive or underperforming assets to generate cash. Book values are generally useless in any valuation because they reflect the historical cost of acquisition which may be little or no resemblance to the current market values. Replacement cost is a better method because it provides a comparison to the alternative of setting up a similar new business from scratch. You must bear in mind that if a company has strong brands or a compelling market presence, and goodwill is likely to be a significant asset. You cannot value goodwill using asset-based approaches and the only proper method of valuation will be based on income generating capacity. In fact, there are hybrid valuation methods that use both assets and income as a basis. Often these methods will yield a more realistic valuation rather than one or the other by itself.
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