Valuation: The Beating Heart of Capitalism

Asset valuation, not profit, is the heart and soul of free market capitalism.

Short-term profit is just a waystation on the journey to create wealth.

The precise goal for making a profit is not taking in money, but making a “net” profit – money which is yours, which you can keep as an asset and add to your capital.  One can take in cash – “make a profit off sales” – but at the end of the accounting period, still end up worse off as total expenses were more than the gross profits earned.

Coming out ahead in the profit and loss statement demands good judgment about contingencies and risks.  It presumes hard-headed calculations of stakeholder circumstances.  First, is your product or service something that somebody wants to buy?  Secondly, will they pay you enough to cover your costs and leave you with a net profit?  Thirdly, will your calculated costs include taking appropriate care of your employees, investors and enhancing or at least protecting your brand appeal?

Then too, the capital value of your firm depends most on expected future net profits.  Making money today, but losing your market next week, is not the road to success in business.

Valuation analysis is the calculation of what “asset” value your firm now has in its expected ability to earn profits in the future.  Roughly speaking, valuation analysis speculatively estimates what your future profits will be and what risks are associated with that expectation. If your present expectations are subject to unpredictable future events, your realistic estimated value is low. You may dream about a rich and glorious future and your dreamy, unrealistic, expectations may come true, but most likely they will not.

In the U.S., a recent judicial opinion on the realism of Donald Trump’s past evaluations of his “assets” exposes the uncertainties of valuation analysis.

What was Trump’s ownership worth in present dollars?  How much would you pay to buy his business “empire” and use it to generate future income for yourself?

In an opinion of September 26, 2023, Judge Arthur Engoron of the Supreme Court of the County of New York, State of New York, harshly criticized the Statements of Financial Condition (SFC) filed on behalf of Donald Trump as false and misleading.

The judge came to this conclusion in the belief that valuation of asset values is a reliable assessment of objective reality.  That belief may well be an illusion.  Value, being an intangible personal preference, varies from person to person.  Some like it hot.  Others like it cold.  “Beauty is in the eye of the beholder.”  “One person’s trash is another’s treasure.”  De gustibus non est disputandum – “One can’t logically prove that one person’s taste is better than another’s.”

Preferences or, as economists call them, “supply and demand curves” and “utility curves,” come in many formats.  Price in money, as a measure of value, will be different for different sellers and buyers depending on the slopes of their utility curves.  I might sell low, but you might hold out to await a different buyer who has a different demand curve and will pay more for the same good or service.  I may need the money now, while you can afford to wait and try your luck.

An objective reality about value only comes into being in a transaction.  When the seller and the buyer have a meeting of minds about price, then that price is a social fact, a non-subjective number.  Yet, what those two people agree to as correct monetary value to place on the good or service may not be acceptable to others.

Valuation methodology, therefore, must be made to happen in an ecosystem of uncertainty.

Valuation is an approximation, a guestimate, of what an average person, one with an expert opinion or just a reasonable person, might think is a correct judgment as to worth.

Actually, the SFC filed on behalf of Donald Trump affirm the obvious.  They contain the following warning to those who will rely on the statements:

Assets are stated at their estimated current values and liabilities at their estimated current amounts using various valuation methods.  Such valuation methods include, but are not limited to the use of appraisals, capitalization of anticipated earnings, recent sales and offers and estimates of current values as determined by Mr. Trump in conjunction with his associates and in some instances, outside professionals.  Considerable judgment is necessary to interpret market data and develop the related estimates of current value.  Accordingly, the estimates presented herein are not necessarily indicative of the amount that could be realized upon the disposition of the assets or payment of the related liabilities.  The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated current value amounts.

In other words, Trump’s valuation experts disclose that their work is open to second-guessing, that it is not “true” like a statement of an uncontested fact, which would be either “true” or “false.”

Valuation paints a picture.  It is not photography.  And as an artistic construct, an SFC is more impressionist than scrupulous in its attention to every small detail or possible contingency.

But there are limits.  The range of reasonableness can have some scope, but not everything that might be said about the ‘value’ of something can be unquestionably reasonable or fully trustworthy.  You can’t treat a valuation opinion as actual money in your hand.  Valuation, to be useful in capitalism, needs standards of due care, credibility and integrity to bring it as close to money as possible.

Then again, to be realistic, what is the value of money?  Is it as good as gold?  Even the price of gold goes up and down.  How well will your dollar bills hold their market value?

Here is a chart on the real value of a dollar over time:

Supply and demand still do drive values.  Spanish police arrested 12 people suspected of stealing 74 tons of olives in the Spanish province of Seville, mere weeks after 6,000 liters of olive oil was stolen in Malaga.  Heatwaves and drought ruined this year’s harvest in Spain, the world’s largest producer.  As a consequence, the price of olive oil at origin has risen 112% since last year.

The purpose of valuation is to facilitate and encourage transactions which produce wealth and increase satisfactions, to reduce risk of failure and imbalance between the parties to a transaction and to promote trust in society and the economy.

Valuations which are unreasonable, though not intentionally fraudulent, are still dysfunctional. They should not be facilitated or accepted.

Judge Engoron, in finding some of the SFCs filed on behalf of Donald Trump to have been unreasonable, beyond the pale of sensible practice and so without sufficient integrity for a fair and transparent capitalism, pointed out details which were in-credible.

For example, from 2012 to 2016, Trump submitted SFCs claiming that his residence in Trump Tower, New York City, was 30,000 square feet in area when, in fact it only had 10,996 square feet.  Use of the larger number led to a calculation of total value which was overstated by some $114-207 million dollars.

Similarly, when the highest sale price for an apartment in New York City was $88 million, Trump’s SFCs reported the value of his property at from $180 million to $327 million during the years 2012-2016.

Now, to be fair to Trump and his valuation specialists, it is within the bounds of cosmic possibility that some buyer might pay those higher prices or close to them for the apartment for who knows what motivation.  But it is not within the bounds of reasonable probability that such a sale would ever be closed in Trump’s lifetime.

Trumps’s SFCs for the years 2011 through 2021 listed the Trump Park Avenue building as one of his assets.  In that building were unsold condominium units.  A number of these units were limited by New York City’s rent control laws in the amount of rent they could charge to tenants.  One valuation appraisal of those units with limited profit potential estimated a value of $62,500 for each such unit.  In Trump’s SFCs, the value of those units was much, much higher, a capitalized value of future income which would never be realized as long as the rent control laws were in force.

Trump’s renown club property in Florida – Mar-a-Lago – was assessed by the local property tax collector as worth between $18 million and $27.6 million between the years 2011 and 2021 as the capital value to be taxed at the legal rate.  In those years, Trump’s SFCs valued the property at between $426,529,614 and $612, 110,496.

The judge relied on a previous court ruling that “[where] the expert’s ultimate assertions are speculative or unsupported by any evidentiary foundation, however, the opinion should be given no probative force …”  In other words, the expert’s opinion is pure hokey or delusional from the viewpoint of the law.  From the law’s perspective, there is no expertise to support such a statement as to market value.  The supposed expert is just telling tall tales to entertain some audience.

Judge Engoron then focused on other not credible conclusions as to the value of Trump’s assets. The lack of credibility which he objected to arose not from theory but from factual discrepancies between legal rights and assumptions as to the value of those rights in the future, the assumptions being not logically supported by the limited nature of the rights owned.

With respect to several golf clubs, Trump had agreed to assume an obligation to pay refundable membership deposits. But his SFC’s from 2012 until 2021 valued that liability at $0 when in fact it was a liability in the millions of dollars.

Another discrepancy attached to Trump’s 30% limited partnership interest in a realty trust which owned office buildings in New York City.  The terms of his limited interest in the trust prevent his use or withdrawal of funds held by the trust.  Trump’s SFCs, however, classified his 30% limited interest as a “liquid/cash asset.”  The judge concluded that it was false and misleading for Trump to indicate that he had access to between $14 some million and $93 some million in liquid assets when he did not.

Trump used the valuation statements for his advantage.  Having property with high valuations is a strategic advantage in capitalism.  You can borrow more and put those funds to work on your behalf and people will credit you with achievement, which reputation can be turned to your practical advantage.  Valuations have consequences that drive market transactions.