Asset Valuation Involves a Three-stage Process Connecting Fundamental and Market data

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1. Asset Valuation Requires Economic Data

 

Accounting information only provides raw material

 

  • Accounting aggregates (e.g. profits, book value, goodwill...) were never designed to support an investment decision

 

  • We adjust many (non-economic) accounting items such as depreciation, intangible assets, operating leases, asset lives, etc...

 

  • We then create a financial business model of the firm, and specifically:

 

    • calculate the amount of invested economic capital (tangible or intangible, on or off balance sheet)

 

    • calculate the economic rent (the cash flow return on invested capital) and estimate its sustainable level

 

 

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2. Asset Valuation Requires a Sound Economic Model

 

The “economic rent” of the firm is the cash yield on its economic capital

 

  • This yield can either be defined as

     

    • An operating cash-flow yield, calculated with maintenance capital consumption, or

     

    • A net cash flow yield, where all capital consumption is taken into consideration

 

  • We like to normalise their level by considering the cash cycle of each firm. These normalised yields represent what the firm should be able to “sustain” throughout a business cycle

 

 

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3. Asset Valuation Requires an Opinion on Market Price

 

We assess valuation only once we have a fundamental view on a stock

 

  • This makes the process research-driven, not market-driven

 

  • Our final assessment on market price will extract, when possible, an implicit level of cash return directly comparable with our own assessment
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