Comparing the incomparable: Adjusting market data to estimate value

by charlene_voisin | December 1, 2012 9:00 am

By Mark T. Cartwright

[1]

The ‘market data approach’ to value is widely accepted as the most accurate method for appraising most types of jewellery. However, many appraisers are intimidated or confused about how it can be applied to their specific assignment. But let’s not get ahead of ourselves.

This method of valuation is also referred to as the ‘sales comparison approach,’ a name that is perhaps more descriptive and easier to grasp. To put it into context, there are three generally accepted methods for analyzing the information appraisers use to assign a value to a property.

The ‘income approach’ is rarely used by jewellery appraisers, since it’s only appropriate when the property being valued generates a stream of income. Instead, a ‘cost approach’ is typically used, or perhaps misused. It involves an understanding of the various costs involved in the production or reproduction of a property. Those expenses might include materials, labour, overhead, taxes, duties, shipping, etc. Once the total cost is determined, the profit margin or markup that is appropriate to the specific market and market level is applied. Generally, the cost approach is most useful for valuations used for insurance scheduling.

The final methodology is the ‘sales comparison approach.’ As the name suggests, actual market transactions are the raw data used to arrive at a value opinion. Traditionally, completed sales were the basis for analysis, however, for many appraisal types, it can be acceptable to utilize ‘offers to sell’ or ‘asking prices,’ although if discounting is common, prices should be adjusted to reflect that reality.

They’re not the same

[2]

A common misconception about the sales comparison method is that only identical or near-identical items can be accurately compared when looking for sales results. Obviously, we all hope that such straightforward comparisons are out there to be found, but often that’s not the case. What we should really be searching for is sales data that can be used for comparison, rather than sales of identical items. If we understand the ‘value elements’ of a piece of jewellery, it becomes much easier to recognize similar value elements in other pieces. Any characteristic of the item that distinguishes it from other similar pieces and creates a perception of value in the minds of buyers would be considered a value element. In a diamond, the well-known 4 Cs are widely recognized as the factors influencing how much a buyer will pay in comparison to another diamond. So, in conducting market research one would try to match as many of those characteristics as possible. However, what if we can’t find a close match?

If we consider the Cs of a diamond, it doesn’t require a great deal of research to discover there is a direct correlation between the carat weight breakpoints and the price per carat within both the wholesale and retail markets. If necessary or useful, it could be expressed as a percentage. For instance, if all other factors are equal, it might be noted that a two-carat diamond costs X per cent more than a one-carat diamond. Or one might look at the prices for round brilliants of fine make compared to well-made princess-cut diamonds. Establishing such correlations allow us to ‘adjust’ sales data based on market evidence, even though the items sold were dissimilar in some way. Within every market there are statistically relevant relationships between value elements, and it’s important to recognize these relationships vary with the specific market. To illustrate, in some regional markets, the carat weight of a diamond overrules the quality of the cutting, while in other markets, the opposite is true. As we begin to see the patterns, our ability to locate comparable properties from which to derive sales data becomes easier and our analysis becomes more accurate.

[3]

Just as important as recognizing what’s important to an item’s value is the ability to understand those characteristics that should be described, but which don’t contribute to its worth in a significant way. A trivial example is whether a diamond is mounted in a four-prong or six-prong setting. The difference between a 57 per cent table diameter and a 58 per cent table is equally insignificant in determining value. If we’re dealing with the truly rare, the number of legitimate value elements becomes very small indeed. Whenever demand far exceeds supply, buyers become far more willing to accept what might otherwise be considered a defect in a property. To illustrate the point, when appraising a three-carat fancy blue diamond, the range of cutting variables that would be acceptable to a buyer at a given price point is much greater than those same factors for a near-colourless three-carat diamond. Even the stone’s actual shape becomes much less relevant, as the colour and carat weight dominate most other considerations. I’m suggesting market research can help us understand what really matters to buyers and what is simply part of the description.

But there’s only one

[4]

What can we do if the item is a one-of-a-kind masterpiece? We must expand our idea of what is comparable by re-examining the factors that create desire of ownership (i.e. value). Is it something intrinsic to the property, such as authorship, craftsmanship, materials, relative size or weight, colour, clarity, etc.? Or is it something extrinsic like symbolism, tradition, fashion, exclusivity, or the status ownership imparts? It is usually a combination of factors, but in most instances, a small number of them will predominate within a given market.

Once we recognize the primary value elements, we can look for sales of other items with similar qualities. As an example, if we’re unable to find sales data for a comparable three-carat blue diamond, perhaps we can recognize a value relationship to a fancy pink diamond of similar desirability that was sold in the same market. Making comparisons across markets becomes more problematic as our familiarity with those markets decreases. Knowing the price for which a given item was sold in Hong Kong is only useful for my data set when I am able to demonstrate a statistically viable relationship to the prices of the comparable items within my target market or when the appropriate market is international in scope. In the case of my hypothetical three-carat fancy blue diamond, that may very well be the case. However, for most jewellery appraisals, the information from a marginally comparable market is less likely to be useful.

Another common though erroneous belief concerning the sales comparison approach to value is that auction results are the best or only place to find sales data. If the intended use of the appraisal indicates the auction market is the most appropriate one, then obviously that’s the best place to look for sales of comparable items.

On the other hand, if most of the sales activity takes place at a different market level, say guild retail for instance, then sales at auction aren’t going to provide very much useful data. In many assignments we’re okay considering bona fide offers to sell in the form of price tags, advertisements, or my personal favourite, verbal communication. Whether you’re an independent appraiser or you provide appraisal services through a retail storefront, it’s important and useful to know your peers in your market and what they sell. It’s wonderful to have the option to pick up the telephone and directly ask the price for which an item is typically sold. As an independent appraiser I pose no threat of competition, however, having co-operative pricing resources is just as important for the retail-based appraiser. In many cases, you’ll get answers to your questions once your ‘competitor’ recognizes the motive for your phone call is to accurately value their merchandise for a mutual client. Remember, they’re often in need of the same information from you.

It’s so easy

[5]

Why should anyone choose the market data approach to value over the cost method? Accuracy. Instead of making assumptions and using a best guess of the wholesale and shipping costs, overhead, and profit margins to estimate value, we can simply look at actual selling prices. “But Mark,” I hear you say. “I’ve got these nifty pricing guides so I don’t guess the wholesale costs. I know how much I pay for shipping and insurance and I know my own markup strategy. Besides, the cost approach is so much easier and faster.” First, it’s vital to understand that easier and faster are not criteria for choosing a valuation method, at least not if credibility matters. It’s also important to realize each of the pricing guides provides a ‘value,’ not a ‘cost.’ They are a compilation of market data from various sources that indicate market trends and the modal or average prices. If I were to call one of the dealers who provide the data to the price guides, then I would be working with a potential ‘cost’ for the stone, but I would still not know if retailers in my market were actually paying that amount. Similarly, if we assume a keystone or triple keystone or half-keystone markup, it is exactly that, an assumption.

The cost approach has its place and can produce credible results when properly utilized. The sales comparison approach is always based on market reality. There’s no need to assume or guess—simply analyze and report.

[6]Mark T. Cartwright, ISA CAPP, ICGA, CSM-NAJA, GG (GIA) is president of The Gem Lab, I.C.G.A., an independent American Gem Society (AGS)-accredited gem laboratory. He has been a jewellery designer, goldsmith, gemmologist, and appraiser for more than a quarter century. Cartwright can be contacted via e-mail at gemlab@cox-internet.com[7].

Source URL: https://www.jewellerybusiness.com/features/comparing-the-incomparable-adjusting-market-data-to-estimate-value/

---