Fundamental Analysis Explained
April 1, 2019

Valuation Analysis Explained

What is Valuation?

Valuation is the analytical process of determining the current (or projected) worth of an asset or a company.

What is Analysis?

Analysis is the examination of data and facts to uncover and understand cause-effect relationships, thus providing a basis for problem-solving and decision making.

Why is valuation analysis necessary?

Valuation analysis is important for investors to estimate the intrinsic values of company shares in order to make better-informed investment decisions.

Valuation analysis is a useful tool for comparing companies within the same sector or estimating a return on an investment over a given time period.

What is the purpose of valuation analysis?

An analyst placing a value on a company looks at the business’s management, the composition of its capital structure, the prospect of future earnings, and the market value of its assets, among other metrics (Qualitative Factors).

How is valuation analysis done?

There are various methods used in the valuation analysis. However, they can be classified into two:

Absolute valuation models

Relative valuation models

Absolute valuation models

This deals with finding the intrinsic or “true” value of an investment based only on fundamentals.

Looking at fundamentals simply means you would only focus on such things as dividends, cash flow, and the growth rate.

Valuation models that fall into this category include the dividend discount model, the discounted cash flow model, the residual income model, an asset-based model.

This analysis is done for a single company and neglects to compare with other companies.

It is time-consuming

Relative valuation models

This involves comparing the company in question to other similar companies.

These methods involve calculating multiples and ratios, such as the price-to-earnings multiple, and comparing them to the multiples of similar companies.

Conclusion

No single valuation model fits every situation, but by knowing the characteristics of the company, you can select a valuation model that best suits the situation.

Additionally, investors are not limited to just using one model. Often, investors will perform several valuations to create a range of possible values or average all of the valuations into one.

With stock analysis, sometimes it’s not a question of the right tool for the job but rather how many tools you employ to obtain varying insights from the numbers.

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