The Importance of Valuations

Investing – and its indispensable technique, valuation – have been said by many investors to be both an art and a science. But while there are tonnes of textbooks on valuation that exist, they are mostly focused on the science side of things.

There just aren’t that many investing texts that discusses the art part of the valuation process. One of the few that does – Investment Valuation – is by the famous finance lecturer Aswath Damodaran from the Stern School of Business at New York University. Any serious investor should at least take a look at Damodaran’s writings; in my personal opinion, he gives a candid account of what valuation really is.

Is valuation necessary?

There are basically two schools of thoughts when it comes to valuation. On one camp you have those who subscribe to the “Greater fool (small-f)” idea whereby the value of an asset is just whatever the next buyer is willing to pay for it. For them, there is no need for any valuation process so long as they can find a buyer (the greater fool) to buy the asset they own.

On the other side of the divide, there are those who believe deeply in the idea that all assets have a real or intrinsic value embedded within them.  As such, investors should never pay more than what an asset is worth (based on their calculations) if they’re looking to make a profit from it.

Let’s use the conglomerate Keppel Corporation (SGX: BN4), currently trading at S$10.63 per share, as an example of what this valuation thingamajig is all about. The company, with very diverse business interests, can be hard to value. However, if you’ve managed to make a good case for its valuation and peg its intrinsic value at, say, S$14.00, then investing in the company would be a smart choice; you’re buying an asset at a price that’s a fair bit lower than what it’s worth.

On the other hand, if your number crunching reveals Keppel Corp to be only worth S$9.00 per share, then a purchase wouldn’t make sense even if you can easily find another buyer who’s willing to pay S$12.00 per share for the company.

So in essence,  we have two camps: 1) Those who think ‘valuations’ are based on what others think or feel about an asset; and 2) those who form an independent view about what a company is worth regardless of the opinions others might have for the asset in question.

Foolish Summary

The idea that there is a methodology to understand the value of all assets seems rational, logically compelling, and attractive to me. Meanwhile, buying an asset and then hoping someone would pay a higher price to take that asset off my hands sounds mightily speculative and risky.

Sometimes, it’s really a case of ‘to each his own’, but for me, the use of proper valuation tools to assess an asset is highly desirable. If not, I’ll just be gambling – without having the odds in my favour.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.