Valuation

People value things all the time: a house before buying it, a car before selling it, a company before investing in it. In finance, valuation uses structured methods to arrive at a reasoned estimate of worth, rather than relying on gut feeling.

There are three broad approaches. The income approach values an asset based on the cash it is expected to generate in the future, discounted back to today, as in a discounted cash flow analysis. The market approach compares the asset with similar ones that have recently been sold or are traded, using measures such as price-to-earnings ratios. The cost approach looks at what it would cost to replace the asset or what its assets are worth.

For example, an investor valuing a small café might estimate its future profits, compare it with prices paid for similar cafés and consider the value of its equipment and lease.

Valuation is part science and part judgment. It depends on assumptions about the future, such as growth, risk and interest rates. Different reasonable assumptions can produce different values, which is why analysts often present a range rather than a single number.