CFM: Basic valuations

Valuation (finance)

In finance, valuation is the process of estimating what something is worth.^[1]Items that are usually valued are a financial asset or liability. Valuations can be done on assets (for example, investments in marketable securities such asstocks, options, business enterprises, or intangible assets such as patents andtrademarks) or on liabilities (e.g., bonds issued by a company). Valuations are needed for many reasons such as investment analysis, capital budgeting, mergerand acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and in litigation.

Valuation of financial assets is done using one or more of these types of models:

1. Absolute value models that determine the present value of an asset's expected future cash flows. These kinds of models take two general forms: multi-period models such as discounted cash flow models or single-period models such as the Gordon model. These models rely on mathematics rather than price observation.
2. Relative value models determine value based on the observation of market prices of similar assets.
3. Option pricing models are used for certain types of financial assets (e.g., warrants, put options, call options, employee stock options, investments with embedded options such as a callable bond) and are a complex present value model. The most common option pricing models are the Black–Scholes-Merton models and lattice models.

Common terms for the value of an asset or liability are market value, fair value, and intrinsic value. The meanings of these terms differ. For instance, when an analyst believes a stock's intrinsic value is greater (less) than its market price, an analyst makes a "buy" ("sell") recommendation. Moreover, an asset's intrinsic value may be subject to personal opinion and vary among analysts.

The International Valuation Standards include definitions for common bases of value and generally accepted practice procedures for valuing assets of all types.