Question

In: Finance

discussion ot two or more concepts or ideas/methods of stock valuation

discussion ot two or more concepts or ideas/methods of stock valuation

Solutions

Expert Solution

Valuing stocks is an extremely complicated process that can be generally viewed as a combination of both art and science. Investors may be overwhelmed by the amount of available information that can be potentially used in valuing stocks (company’s financials, newspapers, economic reports, stock reports, etc.).

Therefore, an investor needs to be able to filter the relevant information from the unnecessary noise. Additionally, an investor should know about major stock valuation methods and the scenarios in which such methods are applicable.

Types of Stock Valuation

Stock valuation methods can be primarily categorized into two main types: absolute and relative.

1. Absolute

Absolute stock valuation relies on the company’s fundamental information. The method generally involves the analysis of various financial information that can be found in or derived from a company’s financial statements. Many techniques of absolute stock valuation primarily investigate the company’s cash flows, dividends, and growth rates. Notable absolute stock valuation methods include the dividend discount model (DDM) and the discounted cash flow model (DCF).

2. Relative

Relative stock valuation concerns the comparison of the investment with similar companies. The relative stock valuation method deals with the calculation of the key financial ratios of similar companies and derivation of the same ratio for the target company. The best example of relative stock valuation is comparable companies analysis.

Popular Stock Valuation Methods

1. Dividend Discount Model (DDM)

The dividend discount model is one of the basic techniques of absolute stock valuation. The DDM is based on the assumption that the company’s dividends represent the company’s cash flow to its shareholders.

Essentially, the model states that the intrinsic value of the company’s stock price equals the present value of the company’s future dividends. Note that the dividend discount model is applicable only if a company distributes dividends regularly and the distribution is stable.

2. Discounted Cash Flow Model (DCF)

The discounted cash flow model is another popular method of absolute stock valuation. Under the DCF approach, the intrinsic value of a stock is calculated by discounting the company’s free cash flows to its present value.

The main advantage of the DCF model is that it does not require any assumptions regarding the distribution of dividends. Thus, it is suitable for companies with unknown or unpredictable dividend distribution. However, the DCF model is sophisticated from a technical perspective.

3. Comparable Companies Analysis

The comparable analysis is an example of relative stock valuation. Instead of determining the intrinsic value of a stock using the company’s fundamentals, the comparable approach aims to derive a stock’s theoretical price using the price multiples of similar companies.

The most commonly used multiples include the price-to-earnings (P/E), price-to-book (P/B), and enterprise value-to-EBITDA (EV/EBITDA). The comparable companies analysis method is one of the simplest from a technical perspective. However, the most challenging part is the determination of truly comparable companies.


Related Solutions

answer all a) Among all the stock valuation methods, four key methods of stock valuation are...
answer all a) Among all the stock valuation methods, four key methods of stock valuation are sometimes used by the organization, Fifo, Lifo, Weighted Average And Simple Average, explain how the application of each would differ using a company of your choice considering the nature of materials that form the basis of the stock in the selected company. b) Using your choice of the company above and the nature of your stock, explain why there would difference in the closing...
can someone paraphrase this please? Stock valuation methods There are several methods for valuing a company...
can someone paraphrase this please? Stock valuation methods There are several methods for valuing a company or its stock, each with its own strengths and weaknesses. There's no one method that's best suited for every situation. Each stock is different, and each industry or sector has unique characteristics that may require multiple valuation methods. Some models try to find a company's intrinsic value based on its own financial statements and projects, while others use relative valuation against competitors/peers. For companies...
1.     Briefly write about the stock valuation methods as discussed in the chapter.
1.     Briefly write about the stock valuation methods as discussed in the chapter.
Valuation on a Multiplicative Binomial Lattice This problem reviews some of the main ideas of valuation...
Valuation on a Multiplicative Binomial Lattice This problem reviews some of the main ideas of valuation on a binomial lattice and the properties of put and call options. You may wish to review the relevant lecture material and readings. Suppose that the price of a share of KAF stock is S(0) = £120 in period 0. At the beginning of period 1, the price of a share can either move upward to S(1) = u S(0) or downward to S(1)...
Why is stock valuation more challenging than bond valuation? Are dividend paying stocks easier to value...
Why is stock valuation more challenging than bond valuation? Are dividend paying stocks easier to value than non-dividend paying stocks? Why or why not?
Safety and Infection Discussion Board 1. Why is it essential that the OT practitioner be proactive...
Safety and Infection Discussion Board 1. Why is it essential that the OT practitioner be proactive in not spreading infection? 2. What are the possible ramifications to a patient if the patient contracts a serious infection while in care? 3. What are the possible ramifications to the OT practitioner if the practitioner contracts an infection due to poor infection control? 4. What part of the OT code of ethics might a practitioner be violating if the OT practitioner is lax...
What are the core concepts and methods of Kinematics? What are the core concepts and methods...
What are the core concepts and methods of Kinematics? What are the core concepts and methods of Dynamics? What are the core concepts and methods of Work-Energy relationships? How all of the above are related? How consideration of others perspectives changed or improved your thinking on all of the above?
There are multiple stock valuation methods. The price-earnings (PE) method is one of the most popular....
There are multiple stock valuation methods. The price-earnings (PE) method is one of the most popular. The PE method is provided by the Wall Street Journal in all of its stock quotations. The PE logic is that future earnings are important determinants of a firm’s value. The PE method has several variations which can result in different valuations. Discuss the assumptions underlying the calculation of the PE ratio. What are its shortcomings?
Comment in one or more than two paragraph this discussion ? Discussion—Behavioral Heuristics There was an...
Comment in one or more than two paragraph this discussion ? Discussion—Behavioral Heuristics There was an incident a couple of years ago where my first partner when I got the job (we both started at the same time) had made many poor decisions both in and outside of work. The heuristic that came up regarding my first partner whom we’ll call Gina for this post was that of expectation or the positive expectation bias, which often fuels gambling addictions and...
1. What are the relevant cash flows for valuing a stock using different valuation methods (Free...
1. What are the relevant cash flows for valuing a stock using different valuation methods (Free Cash Flow to Equity and Dividend Discount Model)? 2. What are the different ways you can find cost of equity? Which is your preferred method? 3. When is a dividend discount model most suitable? When is it not suitable? 4. What would be the input to Excel Rate function if you are trying to find yearly dividend growth rate for a company which paid...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT