Performing Valuation in Times of Turmoil
It has been a week of financial market turmoil. The Dow closed at 8,451 on Friday – over 40% below the 52-week high of 14,279 and down 18% for last week alone. There are a lot of very smart people concerned that the markets and broader global economy are headed for a long-term slump. Within this turmoil there is a lot of discussion about valuation. Here at Valuecruncher we wanted to explain our take on valuation and the analysis we provide.
Here at Valuecruncher we believe that in the long-run markets are broadly efficient – market prices properly reflect the intrinsic value of assets. By intrinsic value we mean a ‘true’ underlying value. However, in the short-term there can be and are inefficiencies. At Valuecruncher, valuation is an attempt to estimate what this intrinsic value is and how it relates to current market prices. At Valuecruncher we do that by calculating a discounted cash flow (DCF) valuation. As we noted, in the longer-term we believe that markets will price assets at this intrinsic value. In the shorter term market prices may differ (either up or down). Our approach is a longer term approach. If someone is looking for a valuation of where a stock will be this week – a DCF isn’t the way to go. However, if you want to understand the underlying value of a stock relative the market price and have a longer-term view – that is where a DCF adds value.
For example: Apple (AAPL). On 4 June, 2008, with the AAPL share price at US$186.10 our estimate of the AAPL intrinsic value was US$146.70. By 23 September 2008, with the AAPL share price at US$131.05 our estimate of the AAPL intrinsic value was US$163.98. AAPL closed on Friday at US$96.80. In just over four months the market price of AAPL has dropped 48% – dramatic times indeed. Our estimate of intrinsic value has changed based on changing assumptions of the underlying business. But what we are trying to estimate is the intrinsic value – and we have argued it is both below and above the prevailing share price of AAPL over the last four months.
At Valuecruncher we will continue to put out our take on the intrinsic value of companies like AAPL and how this relates to the current share price. Our on-line interactive valuation models allow anyone to change our assumptions and calculate their own intrinsic value. In our own analysis we are going to try and avoid rhetoric like “buy”, “sell”, “cheap” and “expensive”. Ours is a longer-term analysis. We still believe that in the long-run that market prices and intrinsic value will eventually converge.
Understanding intrinsic value helps us to understand corporate transactions like share buy-backs. It can illuminate mergers and acquisitions activity. It can even expose opportunities to invest (and dispose) of stocks.
After a wild week we expect there are still some brave souls out there trying at assess value.
Stock position: None.
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