Valuation Models

The Goal of Valuation

The goal of financial valuation is to determine a company's intrinsic value. If the intrinsic value is higher than the current stock price, the stock may be considered undervalued and a good investment. If it's lower, the stock may be overvalued. There are several methods to estimate this value, which can be broadly categorized into absolute and relative valuation.

Absolute Valuation: Discounted Cash Flow (DCF)

The most common absolute valuation method is the Discounted Cash Flow (DCF) model. A DCF analysis attempts to figure out the value of a company today, based on projections of how much money it's going to make in the future. It involves forecasting the company's future free cash flows and then discounting them back to the present day using a discount rate that reflects the riskiness of those cash flows.

Relative Valuation: Comparables Analysis

Relative valuation models determine the value of an asset by comparing it to the values of similar assets. This is often done using valuation multiples, such as the Price-to-Earnings (P/E) ratio or the Enterprise Value-to-EBITDA (EV/EBITDA) multiple. The process involves identifying a group of comparable companies and calculating the average multiple for that group. This average multiple is then applied to the financial metrics of the company being valued to estimate its worth.