Definition: Appreciation is a psychological process that occurs when we recognize the value of an asset’s growth. The process of appreciation occurs when we realize that an increase in value has arrived. The increase in appreciation can occur for several reasons, including increased demand or weakening supply, or changes in inflation or interest rates. The difference between appreciation and depreciation is straightforward: appreciation increases value while depreciation reduces it.
Appreciation rate is a key concept in valuation because it captures the intrinsic value of an asset, even if that asset is difficult to measure or quantify. It expresses the strength of an asset, its longevity and predictability, and its tendency to rise in value as time passes by. Many metrics can be used to measure appreciation, but they all have one thing in common: they are estimates based on past experiences and other information.
Capital appreciation occurs when the market rises against a background of firm demand for a particular asset. Asset values are often determined by measuring the present value of future cash flows. As stock prices rise, investors demand more for their money—often demanding rents and dividends rather than cash payments. As cash flow improves, investors demand more and more equity in assets, driving up prices and making future cash flows more likely.
Appreciation also comes in currency, as when our country’s economy improves or when a company becomes more successful. Countries with stronger currencies are often viewed as more favorable to investment because countries can issue bonds that other countries will buy, thus increasing their purchasing power (through appreciation). Similarly, stocks and other assets held by foreign investors can appreciate because foreign investors have more access to global markets and are therefore able to bid up prices.
The appreciation of brand names and marks can be seen as a positive by some as it reflects recognition of an asset used efficiently and effectively by a business. However, some question whether the appreciation of third-party marks is justified as there could be alternative uses for the mark outside the bounds of the original private label use. Therefore, it is the potential future value that investors should consider as opposed to the current value.
Appreciation is a key factor in value investing because it can convert future cash flows into today’s income. It can be done by measuring any change in value or sales proceeds over a specified period, using either a forward or a discounted forward price. Price appreciation is often measured in percentage terms but can also be expressed as a change in the purchase price over time. When comparing prices paid for similar goods or services, it is very common for customers to hold onto their old currency while buying new ones.