Investment value vs market value: uses and differences

By Indeed Editorial Team

Published 20 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Investment value refers to the amount of money an investor might pay for an asset. This differs from market value, which is usually the free market value of an asset or a company. Knowing the difference between investment and market value can help you with your future financial analysis and make better estimates. In this article, we look at the differences between investment and market value, how to determine them and their different uses.

Investment value vs market value

There is no sure way to guarantee a return on your investment, so consider both investment value vs market value before approaching. Investment values have a singular evaluation that is quite subjective and tailored only to the investor's goals. Likewise, market value often uses a weighted average that might not be all that accurate. Understanding the methods to determine both market and investment values and what makes them different can help when reviewing your assets.

Related: Commercial banking vs investment banking differences

What is investment value?

This type of valuation looks at the value of a certain asset based on an individual's measurement. For example, an investor may use a metric based on their goals, such as the return on their investment. This can quickly tell them if the asset may gain value over time. A variety of other assumptions can influence investment value, such as tax rates, business models and cash flow estimates. Investment values use an individual's calculations and include a variety of other factors. Because of this, valuation results may vary widely.

The stock market uses investment value alongside the discounted cash flow method, which we cover below. The result of this usually informs people of the stock's intrinsic value, which then suggests the recommendations for buying and selling on the stock market. In effect, investment value calculates the value we see in several current stocks. In addition, companies may use investment value to buy and sell certain goods regarding profit turnovers or for analysing a recent acquisition.

Related: How to become an investment analyst (with steps and skills)

How to determine investment value

Investment values vary because of the goals of each investor. In this way, different investors are able to choose the same methods but yield different values. Unlike appraisers who typically adhere to strict guidelines, investors have a choice from a variety of different methods. Below are five of the most common methodologies for calculating investment value:

1. Gross rent multiplier

This is a basic ratio specific to property that shows investment value. You can calculate this by multiplying a single property's gross rents annually with the market-based Gross Rent Multiplier (GRM). Investors calculate the gross rent multiplier with similar properties or assets within the same market. For example, an office building with a potential income of £400,000 divided by the price of £4,000,000 equals a GRM of 10x. By applying this information correctly, you can quickly compare it to other properties in the area.

2. Comparable sales (Comps)

This is very similar to the approach used by appraisers during property valuations. In this case, investors compare the potential purchase with distinct assets or properties. In this way, they can determine a rough investment value.

3. Cash on cash return

This is another simple ratio to calculate investment value. You take the first year's cash flow before taxation and divide this with the total initial investment. For example, if a property has a £50,000 cash flow and you divide this by the purchase price of the property, £500,000, then you have 10%. Using this formula shows you the percentage of your return on investments.

4. Direct capitalisation

The capitalisation rate is the ratio of net operating income (NOI) to the property asset value. For example, if an investor sells a property for £6,000,000 and it has an NOI of £600,000, then the capitalisation rate is 6,000,000 divided by 600,000, which is 10%. The capitalisation rate provides a reliable and concrete statistic to calculate an asset's value.

5. Discounted cash flow

Investors use this more complex model to compare the internal rate of return, net present value and capital accumulation. Some of the above formulas can easily run into problems, such as limitations. You can solve these problems easily by using cash flow analysis.

Related: How to write an investment banking CV (with example)

What is market value?

Market value differs from investment value as its basis is how much money buyers are willing to pay for an asset. We can find this type of valuation using an appraisal process, as in property valuation. The basis for market value is usually publicly available information and this can inform people's decision about investing in stocks or a particular asset. Consequently, there is less ambiguity in the value of certain assets, as market value provides a more concrete method of calculation based on finding a fair assessment for all parties.

We can best see market value in terms of property values. External factors may affect the market value, such as proximity to schools, the reputation of the neighbourhood and the value of similar surrounding properties. This information is publicly available so buyers can calculate approximate market values. In addition, calculating the market value of a business is achievable by simply multiplying the number of outstanding shares with the current price.

How to determine market value

There are usually strict guidelines for determining market value. The best example to illustrate market value is within the property sector, as it is usually quite simple to find the market value of a house. There are three ways an appraiser calculates market value within the property sector, which includes a sales comparison approach, cost approach and an income approach. This also includes a reconciliation of value, which typically follows the first three steps and involves using a weighted average to merge the values from the first three approaches. Here are the methods for determining market value:

1. Sales comparison approach

This approach looks at recent purchases buyers have made for similar assets. You can use this approach in property valuation to provide a rough estimation of a property price in an area where there has been a related transaction. Likewise, when estimating the market value of acquisitions and assets, it helps to compare recent negotiations to find a rough value estimate.

Read more: What is a sales job? (With examples of common sales roles)

2. Income capitalisation approach

This approach defines asset value by the income it produces. The two methods used for this are the direct capitalisation method (as above) and the discounted cash flow valuation method. This approach often seems the most logical, as it can clearly state how much in earnings an asset generates.

3. Cost Approach

This approach is specific to property valuation. It bases the value on the ability to reproduce a property. It also accounts for accrued depredation, or how a property has lost value over time. Accrued depredation relates to three factors, which include physical wearing, functional datedness (such as appliances) and external datedness (the outside appearance). The aim is to repair parts of the property and eliminate all accrued depredation. The appraiser then adds the cost to the value of the land, which determines a suitable value based on cost.

4. Reconciliation of value

The person appraising normally collects the above values, which they reconcile using a weighted average. A weighted average shows the ultimate value estimate. For example, an appraiser may give higher weight to the sales comparison approach because there have been a high number of similar properties sold in that area. Alternatively, they might provide higher weight to the cost approach, as similar properties have lasted for a long time without suffering from any accrued depredation. Here, the ultimate market value may reflect this above the other approaches.

Related: How to identify your work values: a step-by-step guide

5. Differing values

Investment value may be higher than the market value at a specific time. This depends on if a potential buyer gives a higher value to an asset than an informed purchaser. Often, a company moving to a new area may offer a generous offer on a property above the market value to keep competitors out of the area. Alternatively, investment value can be lower than market value. This may happen in property development if an investor decides that it is not one of their speciality. Lower investment value may relate to the costs of training staff on new building techniques.

Related:

  • How to value a company (with definition and jobs list)


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