Thursday, 6 August 2009

C&B: what's it worth?

I have spent much of the week in court listening to highly-paid lawyers argue about company valuations. In the trial, both the plaintiff and defendant hired expensive advisers to tell them how much the company is worth. For one side, it is better that the company is worth more, on the other side, it is better the company is worth less.

By some strange coincidence, the report for the side that wishes the company to be worth more says the company is worth a large amount more than the report for the other side, wishing the company to be worth less.

Both of these long, detailed, reports were put together by well-known financial analysts using apparently objective approaches - the usual graphs, numbers, complex breakdowns of weighted average cost of capital, discounted cashflow analysis, etc - yet still the clients' needs appear to have dictated the outcome of the valuations.

On my desk is a large book titled "Analysing Companies & Valuing Shares". It is not a high level book aimed at market professionals, instead it is aimed at people like you and me, the curious generalist. But I suspect it will remain on my desk unread for many months to come, as piles of more immediately useful paper gets stacked upon it.

One reason why this no doubt fascinating book will remain undisturbed is that I am not convinced a book can tell me how to value a share. I have a suspicion the best the book can offer me is an insight into what people who buy a lot shares think about when they decide to buy shares. This is nearly - but not quite - the same thing as the value of a share.

Judging value is both simple and complex. The simple answer to the question of what something is worth is to reply simply: "Whatever someone will pay for it." In the jargon of finance, this can sometimes be done through a "market test" by putting the asset up for sale and seeing what someone is willing to offer.

The complex mechanisms involve trying to determine an asset's intrinsic value, and - if you are quite modern - trying to understand the psychology of buyers and sellers. The latter is sometimes known to academic economists as "behavioural finance". Value then becomes a mix of a formal calculation about the asset's value - often linked to the income it will provide - with the likelihood of people buying it.

Given the uncertainties around both these subjects, it is hardly surprising even sophisticated people often revert to the simpler valuer methodology, suggesting that value is only a product of someone's willingness to pay.

Next: beating the market, managing the economy

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