The Market Approach to Fair Value
In the short run the market is a voting machine; in the long run it is a weighing machine.
—Benjamin Graham (1894–1976), American economist and investor
CHAPTER 3, “FAIR VALUE FRAMEWORK,” briefly mentioned the three accepted valuation approaches and the need, if all are not applied, to explain the reason. This and the next two chapters deal with their positions in the fair value hierarchy and the various methods used to implement them. It is important that managers, who are ultimately responsible for fair values, understand the strengths and weaknesses of each valuation approach. First we discuss the market approach; as fair value concerns itself with market participants, quoted prices in active markets (Level 1 inputs) are the best basis for its measurement. They are available for many financial assets, certain real estate, selected commodities (such as oil or copper), and some forms of plant & equipment (for example, cars or trucks).
NATURE OF MARKETS
Activity in markets, which have buyers as well as sellers, acts as a form of price discovery. There will always be a tendency to movement as buyers' demands for lower prices conflict with sellers' needs to maintain profit margins. The effect is most obvious with perishables, when at the end of Saturday shopping, unsold items are marked down—some revenue today is better than the chance of nothing, from spoiled goods, on Monday.
In free (unregulated) active markets, buyers and sellers come together ...