But of course half of us haven't and the other half are too afraid to ask.
So in a mild attempt to educate you let me take you gently through it so you'll never have to nod cluelessly again. At the end of these 700 words you will all be able to value your business, your shares, your investment property, even your spouse.
Let's start with this. What is the value of a dollar? Well it's a dollar of course. OK. So what is the value of a dollar in a year's time? Ah, well, it's not a dollar. And this is the issue.
Thanks to inflation a dollar in a year's time is only worth around 97c because by the time you get the dollar prices will have gone up by around 3% so the dollar in a year's time will only buy you around 97c worth of the goods that you could buy today. So it's not worth a dollar it's worth 97c in today's money.
The root calculation
We can now use this to value a company, an asset or an individual. All you have to do is work out how much money they are going to earn in the future and using inflation, turn those future dollars back into today's money, add them all up, add in the value of any other assets they have and that's what the company is worth.
Here's the root calculation: A dollar earned in a year's time is worth $1 divided by 1.03 (1 plus the inflation rate). That's 97c in today's money (97.08c actually). To work out the current value of a dollar earned in two years you divide by 1.03 and then divide by 1.03 again.
Which gives us 94.26c. So 94.26c is all you would want to pay for a dollar someone is going to give you in two years time. So to bust a bit of jargon, the net present value (NPV) of a dollar earned in two years time discounted at the rate of inflation is 94.26c.
So now let's value a company.
Step one: Forecast how much profit it will make each year between now and eternity.
Step two: Use our calculation to "discount" all those future profits and price them in today's money.
Step three: Add up all those discounted profits.
Step four: Add any other assets (cash and buildings). That's the current value of the company and what someone buying the company should be prepared to pay today.
Know your worth
So you can see that by forecasting future profits and discounting the value of future profits back to today's money you can value almost any income producing company, asset, property, person. You can even work out what your own net present value is. If you spend more than you earn, its zero!
So this is what research analysts do with shares. They forecast profits, discount those profits back to today's money, add them all up, account for any other assets, divide by the number of shares on issue and come up with what a share is worth. A lot of them call that a 'target price'.
Of course it's not quite this simple. In the real world they don't use inflation. They calculate a "discount rate" and the arguments over what discount rate to use are endless, but basically, rather than inflation, it is what you could have earned investing your money somewhere else over the year, two years, whatever.
It is the opportunity lost, not the inflation cost. So if you could have put the money in a bond for ten years and earned 5.5% you'd use that instead of inflation.
The bottom line
So that's it. How to value a company or share. Nice concept. But before you go out and value your spouse you should know that it's an imperfect art. Of course it is. Because in the end there are so many forecasts, assumptions and subjective opinions integrated into the calculation of value that it ceases to be a science and ends up an imperfect art.
A basis for the negotiation of price at best. A starting point for an argument between buyer and seller. May the best negotiator win. And that's the stock market.
Marcus Padley is a stockbroker with Patersons Securities and the author of the daily stockmarket newsletter Marcus Today. For a free trial of the newsletter, go to http://www.marcustoday.com.au/
Marcus Padley Stockmarket Secrets is a book for the current financial climate. With global markets crumbling, and many of the world’s leading markets entering into depression – the likes of which we’ve never experienced before – the time is ripe for a straight-shooting approach to money, wealth and investment.
