Investment Value

The value of an asset to a particular owner or a prospective owner for individual investment or operational objectives.

An investment can be defined as cash spent to acquire an asset or item to generate income or appreciation of the asset/item received.

Here, appreciation refers to the asset's value increase over a given period. This acquisition of assets, financial or capital investments, will be done to generate future wealth.

The intent is not to consume it. But instead, the investor wants to earn profits on it or generate cash through this attempt. 

Time, effort, money, or an asset is invested in the form of outlay in the desire and wish to get a more significant payoff than the amount invested.

Value can be described as the worth, desirability, or even utility of an asset, product, or service. The concept of value can be applied to individual products, services rendered, support, a group of assets, or an entire business unit.

Value can also be applied as a business metric-for example, Market value or shareholder's value.

Value can be a currency, a material aspect, or the assessed worth of an asset, sound, or service. Value can be a quantity or number, but it's often used in finance to determine the cost of an investment, a company, and financial performance.

Investors and internal and external stakeholders estimate and forecast the value of a company based on many financial metrics. 

The value of the company can be dependent upon how much profit they generate, cash generation, productivity, and market share, on a per-share basis.

Meaning the profit divided by how many equity shares are outstanding and the number of profitable ventures of the organization.

The process of calculating and assigning a value to a company or an asset is called valuation. 

Equity analysts that work for investment banks often calculate a valuation for a company to determine whether the business is undervalued or overvalued based on cashflows, margins, and other metrics.

What is Investment Value?

The International Valuation Standards describe investment value as" the value of an asset to a particular owner or a prospective owner for individual investment or operational objectives."

Investment value is on an entity-specific basis. However, the value of an asset to the owner may be the same as the amount that could be realized from its sale to another party or entity. 

This value basis reflects an entity's benefits from holding the asset and does not involve a presumed exchange.

Investment value reflects the circumstances and financial objectives of the entity for which the valuation is being produced. It's often used for measuring investment performance and its ability to generate cash flows and profits.

Valuation of any asset is an art. Valuation is not a perfect science, and there is no single correct answer to the value of an asset or financial security. Valuation is, at best, an informed guess or an informed opinion. 

Investment valuation is a much more theoretical analysis of an independent project/asset or group of assets that depend upon the estimates relied upon by the analyst.

Cash flow estimates, tax rates, internal & external financing capabilities, organizational strengths, expected returns, and more are some factors on which the investment value depends.

Net present value(NPV), discounted cash flow (DCF) analysis, and multiple approaches are some standard methods used to determine investment value. 

The investment value can vary depending upon the changes in the methods used by the valuer. All valuers will seek to find the project/asset with the highest return rate.

Investment Valuation Methods

One of the primary reasons to value investments is to assess the return the organization is receiving on the amount of capital invested. Therefore, the money is supported only when a minimum rate of return is expected to be realized.

The cash inflows from the investment start coming in. These cash inflows are expected to pay for the initial investment. In essence, most organizations try to settle in the market and aim for projects to maintain break-even.

And such organizations' primary concern before accepting any project is the payback of the initial investment.

This analysis of outlay and cash inflows will aid in assessing the investors to make intelligent acquisition and investment decisions consistent with organizational objectives and goals.

The valuers may use the same method, but assuming different hypothetical situations, they may come up with different values. And finally, an optimal decision should be carved from both sides, complementing the organizational strategy and goals.

Some of the most commonly used in valuing investments are as follows:

1. Discounted Cash Flow (DCF) Analysis:

The expected cash flows generated from machinery or real estate investment are calculated. Then those expected cash flows are subjected to a discount rate decided according to the organization's minimum rate of return, the weighted average cost of capital (WACC), or even the inflationary rate to get a present value of the cash flows.

The total cash flows discounted are summed up to assess the favorability of the project. Unfortunately, most methods don't incorporate the time value of money. This limitation is addressed by DCF analysis.

2. Comparable Company Analysis(CCA):

It's important to consider that the cash flows can also be harmful or indeterminable. Therefore, the comparable method can be viewed as a "relative" measure for investment valuation.

CCA measures an organization with other companies based on similar financial and corporate metrics to determine the enterprise value. The primary formation that encompasses a CCA is the revenue, expense, EBITDA, gross margin, enterprise value, and more.

It's commonly used when the cash flows are negative or indeterminable. It can be used to compute an investment's range or average value with a comparison to the DCF and DDM models.

The comparable method analysis compares the stock price multiples to an industry benchmark to estimate whether the stock is over or undervalued.

The comparable method is used when the valuer assesses a company to invest in instead of real estate, a plant/machinery, or a project.

3. Dividend Discount Model:

The best method is to value a company's investment opportunity that may provide stable and assessable stock dividends. The DDM model loves the company based on the dividends paid by the company to its shareholders.

Decision-making in the DDM is based upon the rationale that valuing the present value of the future dividends discounted back is an appropriate assessment of the value of the stock. 

4. Gross Rent Multiplier:

The Gross rent multiplier can be used in real or commercial real estate. However, it's usually used to determine the worth of the investment via the rent and property's value.

It's the ratio of the price of a real estate investment to its annual rental income before accounting for expenses. This expense includes taxes, insurance, and other miscellaneous costs such as property taxes, insurance, and utilities.

The resultant figure of GRM is the number of years the property would take to pay for itself in gross received rent.

5. Cash-on-cash return ratio:

This ratio is most commonly used in commercial real estate(CRE) transactions where cash-on-cash return is the cash income on property investment. It's the most simple financial measure that allows the assessment of cash flows from income-generating assets or investments.

Cash-on-cash returns ratio=Total Annual Pre-Tax Cash Flows/Total Cash Invested.

It's complicated to claim one method may answer all the questions of the investment valuation and their assessment. And indeed, investors aren't limited to any one way to value a project/asset/company exclusively.

They may use multiple methods simultaneously and use practices in combination(s) to arrive at the most accurate and efficient result beneficial to the organization. And most consistent with organizational goals and objectives.

Investment Value Vs. Market Value Vs. Intrinsic Value 

As defined earlier, Investment Value refers to the worth, desirability, or material gain expected from the given amount of investment in a project/real estate/company.

Investment value is the value of an asset to the owner or prospective owner for an individual investment. It's much more of theoretical analysis to assess the value of an investment.

This analysis aids in understanding the worth of the investment for the buyer, which helps him in negotiations. Secondly, it may provide a picture of what the business or property is worth.

The Market Value can be defined as the constant currency value of the project/property/company existing in the marketplace, among the industry and competition. So it's the value of an asset at the ongoing market prices.

There is an essential and common confusion between understanding market value and market prices. 

The point is, as the market prices change, the market value of the firm or a project/asset changes too. So, we can conclude that it is no different at all.

Then comes the Intrinsic Value, derived from the intrinsic worth and value provided by the asset or plant. It's a measure of what an investment is worth.

Intrinsic value measure is derived using a complex financial model. As a result, it's different from the market value method in which the ongoing market worth is assumed to be the market value.

The intrinsic value is a calculation instead of the market worth. The intrinsic value is the value embedded in the asset itself. The inherent value's formula is as follows:

Intrinsic Value (IV )= |S-K|

S=Current Price

K=Strike Price

There are other types of investment valuation methods. However, among all the valuation methods discussed, Book value is the most basic yet irrelevant in the valuation. 

In accounting and finance, book value is the value of an asset or property entered in the financial statements.

For assets, the book value is the asset's original cost, less any depreciation or other non-cash expense attached to the purchase.

Book Value(BV) =Original cost of asset-depreciation(or) amortization and impairment cost attached to the asset.

It's irrelevant since it has a historical focus on assessing an asset's value. It's a common understanding that any purchase's chronological or book value isn't a true reflection of the importance of investment.

The Enterprise Value is the valuation of the firm as a whole. This calculation includes all the corporate elements of the enterprise in its valuation. The main purpose is to assess how the firm values when all the following elements are taken into consideration:

These elements are considered to conclude how much investment is required to purchase a company.

Enterprise Value (EV)= Market capitalization+debt+minority interests+preferred equity-cash(or, cash equivalents)

Where market capitalization is the shares outstanding times the current price of the claims, the debt includes short and long-term obligations. 

Financial Statement Modeling Course

Everything You Need To Master Financial Statement Modeling

To Help You Thrive in the Most Prestigious Jobs on Wall Street.

Learn More

Researched and authored by Farooq Azam Khan | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: