Asset-based Valuation Models

An asset-based valuation of a company uses estimates of the market or fair value of the company’s assets and liabilities and, thus, is most appropriate for companies with a high proportion of current assets and current liabilities and few/insignificant intangible assets. Asset-based valuations are frequently used in combination with multiplier models to value private companies or to supplement the valuation of public companies.

Not all companies own assets for which the fair value can be easily determined, and market values can differ significantly from carrying values. Furthermore, asset valuations may be of limited use in a hyper-inflationary environment.

Question

Which of the following famous investing approaches made the most use of asset-based valuation?

1. Ben Graham’s “Net-Net” or “Cigar Butt” approach of finding companies selling for less than their net working capital.
2. Joel Greenblatt’s “Magic Formula” approach, which screens for stocks with low P/E ratios that also achieve high returns on invested capital.
3. Charlie Munger’s/Warren Buffett’s investment approach targeting great companies at good prices. This approach focuses heavily on companies with sustainable moats (competitive advantages) generally achieved with a valuable brand (intangible) and competent management.

Solution

The correct answer is A.

Since Ben Graham’s approach focuses solely on current assets and liabilities, asset-based valuation is a core part of the strategy.

B is incorrect. Joel Greenblatt’s “Magic Formula” is based on a multiplier valuation because of its use of the P/E ratio.

C is incorrect. While Warren Buffett made a number of “Cigar Butt” investments in his day, the investment approach that he is best known for (thanks in large part to Charlie Munger) strays from asset-based valuation towards valuations that take valuable intangibles into account.