IFT Notes for Level I CFA^® Program

LM06 Equity Valuation: Concepts and Basic Tools

Part 4

12. Asset-Based Valuation

An asset-based valuation of a company uses the estimates of the market or the fair value of the company’s assets and liabilities. This valuation method is appropriate for companies that have low proportion of intangible or off-the-books assets. It is commonly used for valuing private enterprises.

Other factors to consider:

Book values may be very different from market values.
Some intangible assets are not reported; asset-based value could be considered a ‘floor’ value.
Asset values are hard to estimate in a hyper-inflationary environment.

Some examples when this method is not appropriate:

A hugely popular restaurant in a rented space. The restaurant is popular because of the proprietor’s cooking skills and secret recipes. The proprietor would like to sell the business and retire. This method is not appropriate as setting a value for the proprietor’s cooking skills is challenging. Only the restaurant’s equipment, inventory, and furniture can be valued.
In the case of a laundry business, the equipment and inventory can be valued at depreciated value or at replacement cost. But intangibles such as convenience due to location, clever marketing, etc. cannot be assigned a value.

The tables below list the pros and cons of the different valuation models we have seen so far.

Comparables Valuation Using Multiples
Advantages	Disadvantages
Good predictor of future returns.	Lagging numbers tell about past.
Widely used.	Not always comparable across firms.
Easily available.	Impacted by economic conditions.
Time-series comparison.	Might conflict with fundamental method.
Cross-sectional comparison.	Sensitive to different accounting methods.
Allows us to identify relatively underpriced securities.	Negative denominator.

DCF
Advantages	Disadvantages
Based on PV of future cash flows.	Inputs have to be estimated.
Widely accepted and used.	Estimates sensitive to inputs.

Asset-Based Model
Advantages	Disadvantages
Floor values.	Market values hard to determine.
Works when assets have easily determinable market values.	Market values often different from book values.
Works well for companies that report fair values.	Do not account for intangible assets.
	Asset values hard to determine during hyperinflation.