Equity valuation
EQUITY VALUATION
The main purpose of stock valuation is to estimate the value of a company or its stock. A fundamental assumption of any fundamental valuation technique is that the value of the stock (in this case, a share of the company’s underlying asset at the end of the day. There are three main models of equity valuation: the cash flow approach). discounted (DCF), cost approach and comparable (or comparable) approach. The comparable model is a relative valuation approach.
The basic principle of the comparative approach is that the value of a share must have some similarity with other shares of a similar class. For a stock, this can be determined simply by comparing a company to its main rivals, or at least to rivals who run similar companies1. Value discrepancies between such companies could represent an opportunity. The hope is that this means that equity is undervalued and can be bought and held until value increases. It could be the other way around, which could be an opportunity to sell short or position your portfolio to take advantage of a price drop.
KEY CONSULTATIONS
The three valuation models for common stock are discounted cash flow (DCF), cost, and the comparable (or comparable)
The comparable model is a relative valuation approach.
The first primary comparable approach is the most common and takes into account market comparables for a company and its peers.
The second comparable approach examines market transactions in which similar companies or divisions have been bought or acquired by other rivals, private equity firms, or other categories of large deep
Types of comp models
Models, There are two main comparable approaches. The first is the most common and takes into consideration the market comparables for a company and its peers. Common market multiples are enterprise value/sales (EV / S), the enterprise multiple, price/earnings (P / E), price/book value (P / B) and price/cash flow available (P / FCF).
To get a better indication of how a company stacks up against its competition, analysts can also look at how its margin levels stack up. For example, an activist investor might argue that a company with lower averages than its peers is ripe for a turnaround and subsequent increase in value if it improves.
The second comparable approach examines market transactions in which similar companies, or at least similar divisions, have been bought or acquired by other competitors, private equity firms or other categories of large investors deep. Using this approach, an investor can get a feel for the value of equity. Combined with the use of market statistics to compare a company to its main rivals, it is possible to estimate that the multiples constitute a reasonable estimate of the value of a company.
Important considerations
It is important to note that it can be difficult to find truly comparable companies and transactions to value a stock. This is the most difficult part of the comparative analysis. For example, Eastman Chemical acquired rival Solutia in 2012 to have less cyclicality in its operations. 5 DuPont’s high-performance coatings business is highly cyclical, so it probably should have been sold at a lower valuation. necessary to determine the adjustments to be made.
Also, using multiple trailings and forwards can make a big difference in analysis. If a company is growing rapidly, a historical valuation won’t be too accurate. What matters most in valuation is making a reasonable estimate of future market multiples. If profits are expected to grow faster than competitors, the value should be higher.
It should also be noted that of the three main valuation approaches, the comparable approach is the only relative model. The cost approach and discounted cash flow are absolute models and focus exclusively on the business being valued, which may ignore important market factors. On the other hand, the stock market can sometimes become overvalued, which would make a comparable approach less relevant, especially if the comps are overvalued. For this reason, using all three approaches is the best idea.
The Bottom Line
Valuation is as much an art as it is a science. Instead of obsessing over the actual amount of stock, it is very useful to go down into a valuation range. For example, if a stock is trading down or below the low of a certain range, it is probably a good value. The reverse could be true at the higher end and could indicate a short-selling opportunity.
