You may also be interested in:

Articles

What's the Difference Between Valuation and Pricing of Assets? FP&A Should Know.

  • By Bryan Lapidus, FP&A
  • Published: 10/2/2017
fpa-bannerBitcoin holders have been on a wild ride. In January 2013, one bitcoin was worth less than $14; in August 2017, it hit $5,000 and then, after China restricted its use, it is valued around $4,000. A recent WSJ article wondered whether it was really worth $50,000, $50, or $0—and concluded the answer was zero. This is not an asset for the risk averse or easily spooked!

To understand what something is worth in financial terms, it is useful to draw a distinction between valuation and pricing of assets. NYU Stern Professor Aswath Damodaran discussed this point in a podcast video in which he notes that you can only determine the valuation of an asset that generates cash flow by then establishing the present value of those cash flows. Examples of items that can be valued include companies, projects, property and debt instruments. Thus, intrinsic value can be calculated based on a set of rules, whereas pricing is inferred by other references. The definition of pricing is best answered by the economist’s refrain: An asset is worth whatever the market will bear.

Bitcoin and other currencies cannot be valued, but rather are priced by the market. They are created by an issuing entity’s decree, usually a government and called fiat currency. Its value is then free to change against other stores of value based on the perception of how it will be managed by the government, and how it will perform relative to other currencies. The purpose is a store of value to enable trades of other goods and services. To a lesser degree, it is a source of speculation and bets on for currency traders.

Gold is a special case. It had been used for centuries as legal tender, but the growth of the economies made gold a cumbersome trading mechanism. It does not have intrinsic value and falls into the pricing category despite its use in jewelry and industry. Gold does have thousands of years of history as a store of value, and therefore has gained trust as an alternative to currencies, even as it trades like a currency. 

FP&A’s Role in Value and Price
The part where this gets confusing is that an asset can have both an intrinsic value and price that determined by a market. For FP&A, the distinction between these two is more than academic. Our forecasts and business cases may include elements that fall into each of these categories. 

Items that are purely priced by the market often exhibit volatility beyond our control to estimate, and yet we must still factor it into our forecasts. The best we can do is to consider a range and sensitivity to these variables when making forecasts, and consider the effect of hedges in our forecasts. Questions to ask include: Do we want to take on trading risk, or will our purchasing group or treasury group hedge against an increase/decrease in the price of a key commodity? What is the price of the hedge (known) and the range cost of the commodity? Do we have a natural hedge in place through the operations of our industry? After the fact, when comparing the variance of actual results to forecasts, many teams will try to factor out this type of volatility to focus on the actions that the business can control. 

Items that can be studied and valued through cash flow analysis will be analyzed through a company’s investment or capital allocation process to determine if they are accretive to the income statement, and continually updated in the forecasts. These are typically projects and internal investments. The variance analysis on these items focuses on what lessons are learned and how can we make better decisions going forward. 

There is also an overlapping case that FP&A should consider, where an asset can be both valued based on intrinsic properties and also priced by the market. The degree that an asset is priced higher than its implicit value may be due to intangible qualities such as perceived value or expected changes, or the “animal spirits” of the market that represent an asset that is in or out of favor. Classic examples of this may be dot-com or telecommunication fiber-optics companies in 2000 that were valued far in excess of the cash flow they could deliver and the housing market during the last recession that still had value even though the prices plummeted. These cases should be analyzed for potential acquisition or divestiture.

Bryan Lapidus, FP&A, is a contributing consultant and author to the Association for Financial Professionals. Reach him at BLapidus@AllegianceAG.com.

For additional insights on FP&A, subscribe to the AFP monthly newsletter, FP&A in Focus.
The Call for Speakers is OPEN
Think you have what it takes to lead an educational session at FinNext 2019? We KNOW you do. Just pick a topic you're passionate about and share it with your FP&A peers. This is your time to shine. 
Submit your Proposal

Copyright © 2018 Association for Financial Professionals, Inc.
All rights reserved.