No.
No.
$5, $10, $20 whatever.
Valuing a company based on their physical assets is rare. The more common method is a discounted future cash flow model. I.E. The present value of the sum of future earnings reduced by a percentage based on the time it is presumed to take to get them and the probablility of getting them.
For example, my Lemonade business has assets worth $1,000. I have a 95% probability of earning $400 this year, 80% probability of $500 the next year, 70% of at least $600 the following year, etc etc. We will assume that I have been in business for five years and in the past have grown at this sort of rate and have a reasonable expectation of continuing to do so.
So, starting with the first year, we’ll assume that the riskless return is 5%. That means $400 a year from now is only worth $380 today. I have only a 95% chance of getting that though so lets make that $360. That brings it to parity versus the riskless return and the risk. But parity is quite enough is it? If it was just equal everybody would keep their money safe and avoid the risk and the wait, right? We need to apply a discount rate to give an appropriate reward for the risk and the wait and the hazards and opportunity costs those entail. Let’s say that discount rate is 6%. That brings us down to $336.
We do that for each of the following years. Eventually we reach a point where we can no longer predict the returns down the road, or the risk is so high and the discounts so high that these future sums are negligible.
Anyway, we add up the sum of these future discounted cash flows and arrive at a number. Let’s call it $3,000.
Should we add in the original $1,000 of assets? No. We’ve built that in already. You see we assume that some of those assets will get old and depreciate (lose value) and need to be replaced and that other assets will have to be bought. For example five years down the road we may assume that we are going to earn $800. At that time all of the lemonade stands that we have today that are nice and shiny new and worth $1,000 will be old and decrepit and worth $20 and in need of replacement. Every year we’ve been putting aside a portion of our earnings into a capital fund to replace these assets when we needed before we count them as income. Therefore, it really doesn’t matter for valuation purposes what our assets are worth.
To look at it another way, consider a Doctor. Lets say he makes a million dollars a year with his business, but he rents everything, office space, machinery, etc. His sole asset is a stethoscope worth $15.
Do you think you could buy him out for $15 or become his 50% partner for $7.50? No. Clearly his business is worth a lot more as a going concern than the value of its assets.
The value of assets is really only important if we are liquidating (ceasing business and selling things off.)
I’ve grossly simplified but that’s the gist of it.
No.
Why would I ignore dividends? Why do you want to? But if you insist, we will.
When the market is acting efficiently as a discounting mechanism it is not creating wealth, but reflecting value. Let’s say a company starts with $1,000 in assets, and a thousand shares divided among 100 investors. Thirty years Michael Dell takes that $1,000 and in his dorm room he builds five computers and sells them for $1,500. He reinvests that money and builds 7 computers that he sells for $2,200, reinvests that and builds 10 computers that sell for $3,000 etc etc for fifteen years. At the end of fifteen years he sells 10 billion dollars worth of computers and instead of a dorm room he has a corporation, factories, employees etc. but has never paid a dividend.
Do you think the original share is still worth a dollar? If it’s worth more has the stock market created that wealth or has the company created it?
You could apply the dividend discount model which would calculate a value based on the discounted sum of future dividends, or, if that number comes out to lower than the actual assets then you might value the company according to liquidation value.
That’s the same question as #1. Same answer. No. Actually, you can view it that way if you want, just not if you want to view it meaningfully.
The question you are really asking is if the market prices itself accurately. This question is known as the Efficient Market Hypothesis, and is a very deep question important on many levels. If the market were efficient that it would be a perfect discounting mechanism and their would be no advantage in investing in any given stock or asset over any other given stock or asset. All returns would be properly discounted and therefore equivalent.
However, the efficient market hypothesis appears to be false. Most economists will concede the “weak” form of the efficient market hypothesis which is that over time the markets have a kinda sorta tendency towards efficiency.
So, to answer half your question, yes markets sometimes get hyped but the tend to correct over time. Bear in mind that I’m also being simplistic because your questions are only dealing with half the equation. You can’t simply value a business based on the business. You have to give as much if not more consideration to the needs and desires of the potential purchasers.
To see my point, consider this simplistic example: You live in a house worth 1 million dollars. Tomorrow, everybody dies but you. You are the last person on earth. How much is your million dollar house worth?
Nothing about your house has changed, but your pool of potential buyers has just evaporated, hasn’t it?
A price assumes a compromise between a buyer and seller. There is no way to price an asset without a market, and in pricing an asset you must take into account the needs of the market.
Let’s say the tangible value of the stock market no matter how you wish to look at it remains unchanged for ten years in a row, and yet the stock market goes up. Would this imply hype or an overvaluation? Not necessarily.
It might just mean that money is easy and assets are hard. If there is a lot of money chasing only a relatively few stocks the stocks will tend to be priced high. You must also look at the rest of the markets, and realize that their percieved potential returns compared to the stock market will tend to affect its valuation.
But sometimes people having relationships invest in the long term, marrying people with prospects rather than people with money now. So I think your example is right on the money.