Assumptions in "valuation"

A student walked to me after a valuation class and asked me " Abhishek, it is a beautiful subject. I don't think anyone of us would lose marks. It involves taking any assumptions and then using formula based on these assumptions." This made me think and think hard. Is valuation all about taking assumptions and proving your assumptions?

The answer I finally arrived at is a firm no. You have got the whole process of valuation wrong if you think that is what valuation is all about.Through this piece, I aim trying to reason out why is this approach wrong.
Let us start by defining valuation. Valuation is the process by which we determine the "most likely value" of an asset, project, firm, business, share, goodwill etc. If the existing price is lower than the "perceived value " of the asset then we should sell the assets.
Hence, logically it can be inferred from the above statement that to determine the most likely value we need to have a complete understanding on what makes a buyer pay for the asset.Thus, all the assumption that an analyst makes is to come at the most logical value. These assumptions are not made to make the life of the analyst easy. Following are the important attributes of assumptions that analysts make:

1. The assumptions should be logical.
2. It should be in line with the assumption generally made in the given industry.
3. The assumption should never be made keeping the end result in mind.
4. Assumptions cannot be tweaked at the end so that the valuation looks justified

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +