How Investors Can Evaluate Optimal Prices When Trading On Secondary Markets
Exploring Valuation Fundamentals
This article is part of an ongoing series on the basics of investing in and trading digital asset securities in the U.S. The last article was on securities exemptions and how investors can use them to gain exposure to new businesses. This article explores how the value of digital asset securities can be assessed.
When volatility spikes, investors often go back to fundamentals to evaluate the benefits of trading in or out of their current positions. By knowing more about valuation basics, investors have the potential to make more informed decisions about whether or not to adjust their portfolio. Let’s review some of the basics for trading on secondary markets.
Plainly, valuation determines the current or projected value of a company or asset. Valuations are calculated through a variety of financial analyses, including but not limited to, the composition of a business’s capital structure, the prospect of its future earnings, and the market value of its assets. While models for both fundamental and technical analysis exist, here we will focus mainly on fundamental analysis.
Often, fundamental analyses are undertaken to evaluate core metrics of business performance. Within fundamental analysis, there are two main types of valuations: absolute and relative. Absolute valuation models can help investors gauge the intrinsic value of a single business using dividend discount models, discounted cash flow models and asset-based models, depending on the type of business.
On Securitize Markets1, one way investors can analyze digital asset security fund performance is by comparing the Net Asset Value (NAV) to current price. NAVs represent the net value of an asset minus its liabilities, divided by the number of outstanding shares. If there is a difference between the NAV and the current price, investors can deduce whether the fund is trading at a discount or a premium, depending on if the change is positive or negative. This is just one way of assessing absolute valuation. While NAVs are more typically used for evaluating funds, some companies are beginning to follow in their footsteps.
Because funds invest in underlying businesses, fund performance can often be reflected in the growth and adoption of those individual businesses. But not all businesses operate the same way. So, how can traders compare them?
Relative valuation models can help assess performance across similar investments. These models include price-to-earnings (P/E) ratios which can help investors weigh the relative performance of an asset or company against competitors using a common denominator. By using P/E ratios as a common denominator, it becomes possible to assess individual company performance against a group of competitors, even if those competitors are structured differently or offer slightly different products.
These fundamental valuation techniques can offer insight into how investments measure up in the marketplace. In situations where both absolute valuation and relative valuation methods yield similar results, investors may want to do additional research.
In the next article, we will discuss how price discovery works in a digital asset securities marketplace. To learn more about market mechanics and price discovery, sign up for updates here.
