What is Commodity Valuation?

What is Commodity Valuation?

Commodity valuation is the process of deriving the intrinsic value of a commodity under optimal market conditions. In a perfectly competitive free market, the price of a commodity reflects the intrinsic value of that good.

Commodity valuation follows the classical economic principle of arriving at a price by studying the intersection of the demand and supply curves of a good, which is also called the break-even point.

Commodity valuation is the process of deriving the intrinsic value of a commodity under optimal market conditions.

Commodity valuation follows the classical economic principle of arriving at a price by studying the intersection of the demand and supply curves of a good, which is also called the break-even point.

Commodity Valuation – Process

The process of valuing a commodities company includes “normalizing” its earnings. It means to average a company’s cash flow over time to cover a typical economic cycle. Normalizing enables investors to understand the revenue, earnings, and cash flow of a company. It can be done either by calculating the average price of a commodity, after adjusting for inflation or by arriving at the fair market price or spot price after examining demand and supply.

An alternative for the same is to study futures markets and use market-based prices to estimate the future cash flows of a company. It is preferred by analysts as it is implicitly risk-assured due to a built-in hedging mechanism. An investor worried about the performance of a company can purchase futures and artificially drive the price of the same.

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