Question

Why is understanding stock valuation so important for businesses? Explain at least one method used and the pro’s as well as the con’s of the valuation. What role would the valuation play in an acquisition analysis?

Answer 1

valuation is essentially the price that one party will pay for the other, or the value that one side will give up to make the transaction work.  Both sides in an M&A deal will have different ideas about the worth of a target company: its seller will tend to value the company at as high of a price as possible, while the buyer will try to get the lowest price that he can .

Various methods of stock valuation are -

*  Discounted Cash Flow

* Comparative Ratios

* ?Replacement Cost

Pros

* It consideres the closest estimate of a stock’s intrinsic value. It’s considered the most sound valuation method with respect to probable assumptions.

* Unlike other valuation methods, DCF relies on free cash flows, considered to be a reliable measure that eliminates subjective accounting policies.
*  DCF isn’t significantly influenced by short-term market conditions or non-economic factors.

* DCF particularly useful when there’s a high degree of confidence regarding future cash flows.

Cons

* Includes a tidious calculations a small changes in values my impact the result .

* It tends to be more time-intensive compared with other valuation techniques.

* valuation is a moving target: If any company expectations change, the fair value will change accordingly.