Question

Provide several criticisms of relative valuation. Which method of valuation do you think is more accurate, relative or discounted present value (DCF or intrinsic value) ? Why? How would rising risks or rising interest rates affect multiples? DCF? Be specific about how rising risks or interest rates influence multiplers? DCF? How important to valuation is classifying a firm into the correct industry? In what industry would you classify Amazon (past and future)?

Answer 1

There are mainly three valuation method present

1. Cost Approach
2. Market Approch I.e. relative method
3. DCF i.e, intrinsic value

Relative Method (Disadvantage):

In this method for valuing any firm, the relative firm in the industry is being considered.

In this approach it is difficult to find exactly same relative firm which carries same kind of business with same environment.

This method will limit the assumption by taking other's comparables which might not be similar to our work conditions and environment.

In this method as it is directly compared with other firm it requires less information which may lead to inaccurate valuation of firm.

Discounted Cash Flow:

In this method using many multiples future cash flow is being forecasted and then discounted at expected rate of return.

In this method one big disadvantage is that this requires so much data to value a firm. If any mistake or inappropriate data has been forecasted than it will lead to inaccurate valuation.

DCF or Relative method?

Though DCF requires more data that lead to accurate valuation of asset/firm.

So I would prefer DCF method for valuation.

Risk of Rising Rates.

This will affect the data forecasted for future cash flow

If Inflation increases more than forecast that will lead company's profit go down than expected.

This will also lead to reduce growth rate of company/firm

and consequently Net earning and all related multiples will change like ROE, ROA, expected market price n all earning related multiples will get affected. Also the forecasted cash flow will get changed as if inflation rate goes up, expected rate of return will also go up and result will be wrong valuation of asset/firm.

Importance of classification in similar Industry:

It is very important to classify an asst/firm in similar industry because investors compare the industry with similar firm and for buying stock or share it gets very much important to know exact flow and earning capacity of an industry.

If we compare with firm/ industry having wrong characteristic than our comparables than it will lead to wrong investment and wrong decision making.

Classification of Amazon:

Amazon has changed his line business from the date of structure till date

Like earlier it was tech company then it became e-commerce giant

and now by introducing amazon prime video to alexa n echo I describe it as tech company.