How Valuable are You?
By Attila Sepkin | October 06, 2022
According to each of our mothers, we are the most beautiful and intelligent young adults in the world. That is, until we go out into the world. Applying these incontrovertible truths, we might be dumbfounded when our crush ignores our message or when we receive a test we did not ace. What is this stark contrast? Is our mother wrong- are we not perfect? Then, how do we objectively assess ourselves within society?
Look no further than the Financial industry’s bread and butter: valuation. In principle, it is simple and objective. It is a matter of deeming what something is worth: what one will pay for it. But in practice this is a complex problem, and there is rarely one answer. Even in a Financial world composed of objective metrics and numbers, valuations of the same investments differ drastically. One’s trash is another’s treasure; not everything is black and white. Nonetheless, to assess ourselves, we can implement three analytical strategies that are the crux of Financial valuation- and I believe they are widely used in our daily lives already.
Market valuation is a technique where one solely considers the market’s interpretation; the market’s supply and demand is used to compute the total value of a company’s equity (stock). Intuitively, this tactic seems infallible- if value itself is determined by the market, then how could it be incorrect? But market sentiments are consistently inconsistent. The market itself is a condensation of chaos: hundreds of millions of independent investor transactions- investors who are savvy, clueless, or something in between. And this results in prices that can be volatile year to year or even day to day. And ultimately, prices that are not quite reflective of an item’s true worth.
Incorrect Market valuations can be seen with trillion dollar companies: Meta Platforms Inc (NASDAQ: META) saw its Market Capitalization almost half (down 42%) in the last six months. And they can be identified in more subjective matters: for example, a student who is shocked by the grade they receive on an essay. Fundamentally, the market valuation (i.e. Professor’s assessment) does not align with the student’s valuation. But who is to say what the correct value is? Had it been brought to another Professor, maybe it would have been judged favorably. After all, Van Gogh’s unsuccessful art career drove him to insanity- now his work is lauded worldwide.
Analyzing precedent transactions and comparable companies is a similar technique. Oftentimes, items are bought and sold that are akin to others. Two companies with similar quantitative and qualitative characteristics should be evaluated similarly by the market. Employees with similar qualifications and abilities often get similar promotions. Athletes with similar skills and careers often get similar salaries. It is a surprise- and based on valuation, an outright error- if two similar items are valued much differently. But due to the market’s role, this can be seen. Companies can be acquired for varying premiums: Twitter was recently purchased by Elon Musk for $44 billion, where Instagram was purchased by Mark Zuckerburg for only $1 billion in 2012. And in life, in environments where certain individuals are glorified, equally talented individuals may be mistreated. Nonetheless precedent transactions serve as a benchmark- with a grain of salt.
Discounted Cash Flow Analysis aims to absolve this problem; it minimizes the influence of market jostling and attempts to derive its own internal valuation of the investment. In Corporate Finance jargon: it projects an investment’s future Free Cash Flows and calculates a Net Present Value for them and the investment. In everyday language, it determines the precise value of an investment now by estimating its future earnings (under various assumptions). Thus, it computes an internal (independent) value. And as such, the market is simply a proposer of deals, offering one price one day and another one the next. And each time, we consider its offer versus our own evaluation; we take it or leave it.
Ultimately it is difficult to precisely gauge our valuation of ourselves in many respects, whether it be our academic abilities, appearance, likability, athletic skills, etc. However if we cohesively implement these techniques- as we already do without conscious consideration- we can arrive at a fundamentally sound answer. Just as with Discounted Cash Flow analysis, your own assessment of yourself is the crux. Market Valuation and Precedent Transactions/Comparable Companies supplement and serve as a gauge; they allow you to chisel and polish your assessment with external perspective. No opinion is as valuable as your own. But others must be considered- with a grain of salt of course, especially Mom’s.
Edited by Michael D'Ambrosio