# What Is the Value of an Investment That Pays?

by Walter Johnson

The value of any paying asset is primarily about the time value of money. Because of inflation money in the future is inherently worth less than money right now. Normally, concepts like present value are figured for bonds, but a looser concept of present value can be used for any annuity, or even for any sort of investment that is expected to pay dividends in the future.

## Present Value

In the bond market, present value is a simple mathematical concept. It refers to the amount of money you need to pay now to receive some expected return in the future. If you have a \$100 bond paying 10 percent interest compounded yearly, then the present value of that \$100 for one year's interest is roughly \$91. The lower the rate of return, the higher the present value. Simply put, this is because the rates of interest represent payments of money above the \$100 you pay now to buy the bond. Hence, as interest is compounded, this lowers the value of your initial payment.

## Value and Capital

A paying investment has a market and a book value. This difference in value summarizes the entire problem with valuing securities. The entire purpose of valuing investments is to grasp the nature of the prices charged and the dividend paid. For example, certain firms pay dividends to their shareholders to attract new or different investors. Stocks can be overvalued, and commodities can be inflated due to speculation or false information. Hence, the market value of an investment might be high and attractive. The book value, that is, the actual value of the capital and its productive work, however, might be quite unattractive.

## Value and Markets

The basic valuation procedure and theory is the same for all investments. Valuing a stock that is paying dividends and/or capital gains takes many variables into account. For example, a stock with a high dividend might be worth far less than its market value since its value might be inflated. If many people are buying a stock, hence driving the price up, your capital gains realized through this increase in value can be based exclusively on market sentiment and not the firm itself.

## Uses and Problems

Valuation theory centers around placing a current paying investment within a framework that measures staying power. In other words, it measures the genuineness of the investment. For example, the infamous junk bonds of the high interest 1970s were based on high-risk, high-yield investments. The higher the interest rates, the more conservative the lenders. Junk bond markets therefore developed to fund the riskier, yet more innovative and dynamic small firms. The reality is, however, that the actual capital that these bonds sought to finance was unstable. Hence, the actual value of any paying bond in this market was equally unstable.