Question

• Discuss why the two valuation approaches (present value of cash flows and the relative valuation ratios) are competitive or complementary.
• 250 words minimum initial p

Answer 1

Present Value of cash flows

Present value is the concept that states an amount of money today is worth more than that same amount in the future. In other words, money received in the future is not worth as much as an equal amount received today.
Money not spent today could be expected to lose value in the future by some implied annual rate, which could be inflation or the rate of return if the money was invested.
Calculating present value involves making an assumption that a rate of return could be earned on the funds over the time period.

This includes free cash flow, operating cash flow, dividend etc.

Relative Valuation Ratios

A relative valuation model is a business valuation method that compares a firm's value to that of its competitors to determine the firm's financial worth.
One of the most popular relative valuation multiples is the price-to-earnings (P/E) ratio.
A relative valuation model differs from an absolute valuation model which makes no reference to any other company or industry average.
A relative valuation model can be used to assess the value of a company's stock price compared to other companies or an industry average.

This includes comparision of earnings. book value, sales etc

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Key points to note regarding the approaches

• Both the methods are used for valuation of shares / stocks.
• Present value method evaluates the firm's performance basis its own cash flows whereas relative valuation compare the firm's performance with its industry / peers.
• Both these methods come with their own advantages as well as shortcomings
• Although both methods serve different purposes, Using both the methods simultaneoously gives opportunity to measure a stock's performance on propriety as well as comparative basis; thus these methods do indeed complement each other.