Question

In valuing shares, several valuation methods have been highlighted. What are they and which one is superior (simpler) among them?

Answer 1

There are two main methods of valuing shares are-

1. Absolute valuation

Under this, we find the true value of the investments. We focus on dividends, cash flow, etc. Under this we have a few models such as dividend discount model, discounted cash flow model, residual income model and asset based model.

Dividend discount models shows the true value based on dividend. We use the Gordon growth model to calculate investment based on dividends.

Discounted cash flow model (DCF) is used when we use company's discounted future cash flow to value the business. It can be used for both companies that pay dividend and also for those who don't.

2) Relative valuation

Under this we compare a company with other similar companies. Calculation is done on the basis of multiples, ratios, etc.

The comparable model - under this we don't find the intrinsic value for the stock. We compare the stock prices. It is based on the law of one price. As per the law of one price, two similar assets should sell for a similar price.

This can be used for all circumstances but the company should only have positive earnings.

If we talk about superiority of these models, not every particular model fits every situation but we can choose the best by seeing the situation and the company under consideration.