THERE has been a lot of misunderstanding about the standards of value. There are six common standards of value: fair-market value, intrinsic value, book value, investment value, liquidation value and fair value.
To most investors, they appear to be the same. However, there are distinctive differences between them. We should use different stardards of value for different business scenarios and purposes.
Fair market value (FMV)
This is the most commonly used standard of value in any business appraisal. It is frequently used when we buy or sell a property asset or a company, especially a private limited company. It is defined as the price at which the asset or company would change hands between a willing buyer and willing seller, each acting with complete information about the company and under no unusual duress.
Note that buyers and sellers should have all the relevant information about the asset and not be under compulsion to buy or sell. In view of the current weak economic situation, if the seller is forced to sell his property to reduce his debts, the transacted value is not FMV. One of the key characteristics of this FMV is the seller should not be under any pressure to sell the asset.
It is always difficult, especially to the buyer, to obtain all the relevant information on any particular asset or company. In most times, the seller has more information than the buyer. Hence, to comply with this standard, the seller is required to disclose all relevant information pertinent to this asset to the buyer before selling this asset.
Intrinsic value
This is the value derived or computed by research analysts. According to Benjamin Graham, it is driven by the earnings power of a company. Sometimes we may wonder why different analysts derive different target prices for the same listed company.
If you understand the expression “Beauty is in the eye of the beholder”, you should be able to understand that different analysts would generate different target prices for the same company.
According to the fundamental principles of any investment analysis, as long as the analysts have reasonable basis to derive the final target number, it will be accepted as the intrinsic value of the company.
Book value
This is computed by the difference between a company’s assets and liabilities. Sometimes we can also label it as the value of the owners’ equity, net worth or shareholders’ equity. This value will reflect the total cost or total money invested in the company.
Under a normal economic environment, it will be very difficult to find a company’s market price selling lower than its book value. However, as a result of the current weak economic and stock market condition, a lot of listed companies have been selling lower than their book value.
Investment value
This value is only applicable to a particular buyer and not the population of willing buyers. It is the value that a particular buyer will generate from investing in the asset.
Different buyers have different investment objectives and different financial positions. As a result, different buyers will generate different cashflows and profits for the same asset.
For example, for the same shoplot, one may use it for education purposes whereas another may open a restaurant. The cashflows that can be generated from education or restaurant businesses will not be the same.
Hence, different buyers will have different investment value from the same asset.
Liquidation value
Under a normal business environment, we hardly use this value as we always value any assets or companies as a going concern where we assume the business is up and running and active in its pursuit of revenue and profits.
If we intend to close down or liquidate a company, we will use liquidation value as it is the value of the company upon disposition of all tangible and intangible assets. There are two levels of this value whether it is part of a planned or a forced liquidation. The value generated from a forced liquidation will be the lowest as all assets will be disposed in the shortest possible period of time.
Fair value
This is subject to the interpretation by the court officials overseeing the transaction. In any dispute, the final value determined by the court will be viewed as fair value, which is fair to the buyer and seller.
● Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.
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