What is a fair price?

June 11, 2008 3:27 AM

How do I assess the value of an offer I received for an investment I own?

I own a tiny interest in some property which produces oil revenue — about $125 per quarter. I have been offered $2,140 for it. How can I assess the value of this offer? At 5% annually, the future value of $125 per quarter overtakes that of $2,140 in about five years, but I don't have a good feel for what that means in terms of the fairness of the offer. Obviously, if someone offered me more than $12,000 for the property, I'd take it, because the quarterly interest (again, at 5%) on $12,000 is $125. On the other hand, $125 is clearly too little, because I can get that much from my investment in a single quarter. So a good price is somewhere between $125 and $12,000. But where? If there are any good rules of thumb for dealing with this sort of problem, please tell me.

posted by ubiquity to work & money (10 comments total)

Surely someone will have accurate figures, but that seems very low to me. For instance, I could rent my house for a net *profit* of about $1200 per month. That would be about $75,000 over five years. But my house is worth several times that. So this ratio wouldn't be a good deal for me in terms of selling my property. And more to your concern, there's speculation that oil prices will continue to rise - and I'd imagine that the $125 you get per quarter will go up, possibly a lot.

If you don't need the money for something immediate (and $2140 can't change your life too much anyway), you'd be better off collecting that $125+ per quarter and holding on to it, at least at that offer.
posted by Dee Xtrovert at 3:49 AM on June 11, 2008

How long would you hold to this investment otherwise? Are there any reasonable expectations as to when the oil might run out?

Assuming you are looking at this strictly number wise, I think you are heading in the right direction. How much would you expect to get for this in the long-run, not just 5 years? If you hold on to it for 25 years, it could be worth $7,113. But if you sell it now, at least you get the money up front to reinvest.

This sounds like a reasonably safe $125/quarter investment, for the moment. I'd ask for a bit more than $2,140. Is there anything else the property could be used for?
posted by toaster at 3:52 AM on June 11, 2008

Yeah, try to figure out how much oil is there. I mean, how can you say it makes "$125 per quarter" when the price of oil has been skyrocketing? If oil goes from $130/bbl to $200/bbl your quarterly take should go up too, right?

I'd hang on to it unless you need the cash or have another opportunity.
posted by delmoi at 6:01 AM on June 11, 2008

Hang on to it!
Even if this is a depleted field (and you should find out about this from the extraction Company), as oil prices rise, more expensive methods of extraction (such as injecting steam) will be financially viable.
posted by lungtaworld at 6:13 AM on June 11, 2008

Your investment is also going to be inflation-resistant, which is quite something considering the real yields of treasury securities right now. Don't compare what you're getting with nominal yields; the market is paying a lot for inflation resistance right now.
posted by goingonit at 7:11 AM on June 11, 2008

Here's the way I'd look at it, although there's a huge missing variable: the amount that the price of your investment is likely to increase over X years. Let's assume 5% annually, just for a number (but I have no idea here):

You currently receive $500 a year, and it grows at 5% a year. If you do nothing but hold on to the money, over 20 years, that's a total of $16,532.98.

If you, every year, take that money and throw it into a decent growth stock mutual fund, and that fund performs at 10% (reasonable, as the market has averaged that forever), you will have a total, after 20 years of $311,115.72.

However, if you take a lump sum of $2140.00, throw that in a decent growth stock mutual fund and it averages 10%, and you don't touch it for 20 years, you should have......

$122,568.50

So the overall decision is: which are you more likely to do?
posted by griffey at 7:38 AM on June 11, 2008

How much did you pay for the investment in the first place? And how long have you owned it? This is critical, because the potential buyer should be offering you at least your own purchase price plus another 3-5% per year... as a base price.

At least that's how I understand it, though I know nothing about oil.
posted by GardenGal at 8:08 AM on June 11, 2008

How much did you pay for the investment in the first place? And how long have you owned it? This is critical, because the potential buyer should be offering you at least your own purchase price plus another 3-5% per year... as a base price.

No. Investors don't care how much things used to be worth. They care about how much something is worth today and how much it's likely to be worth in the future. Its value in the past isn't necessarily connected to its value today, let alone tomorrow. It's impossible to answer the question without specific information about the property.
posted by smorange at 8:26 AM on June 11, 2008

Thanks for the comments so far. I believe this money comes from a long-term lease on some property, not from royalties, so the $125/quarter is stable, and even if oil goes through the roof — oh wait, it already has — I don't think I have any way to profit from that. And although I agree with smorange that what I paid doesn't matter much, in this case I paid nothing as I inherited it. I don't know the original basis.
posted by ubiquity at 8:42 AM on June 11, 2008

The present value (PV) of a seemingly perpetual investment that returns $500/yr for life is = $500/.05 = $10000. This assumes that the perpetuity is calculated at an annual interest rate of 5%. These are before tax figures. If $125 is take-home after taxes, that $10000 goes up fairly significantly.

What he offered you assumes a great amount of risk associated with the investment and/or he lowballed the shit out of you. With the perpetuity formula, you can adjust the interest rate to match the level of risk you think the investment has. For example, if it's as risky as an oil stock, I would change the interest rate to 8-12. If there is substantial stability in the operation, the property, and the amount of oil in the ground, I would lower the rate to 3-7. Given that you said that it's on a long-term lease (terms would be helpful to know) on property, and not on actual production or profit, I'd consider your investment to be pretty safe, and stable. So I think that using the 5% level could be accurate, which would ultimately value your investment at or above $10K.

There are quite a few variables that we haven't discussed, like length of lease, what happens if the property is sold, what happens when the oil dries up and the business files for chapter or dissolves, is there any upside to the $125 if the property value increases, etc. These are all pretty serious considerations when valuing the investment.
posted by SeizeTheDay at 8:59 AM on June 11, 2008 [1 favorite has favorites]