Explain the general criteria for picking a suitable way to value a particular company
The idea
The right model depends on the company, the data and the purpose. It should fit the business: dividend models for steady payers whose dividends track earnings, free cash flow models for firms whose cash generation differs from what they pay out, residual income where free cash flow is negative for years, and asset-based approaches where assets are mostly financial or liquidation is likely. It should suit the quality of the data available, since a model is only as reliable as its inputs. It should also match the purpose, for example a buyer seeking control cares about free cash flow rather than the dividend the current board pays. Analysts often apply more than one model and reconcile the results rather than trusting a single estimate.
In the app: 1 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Equity Valuation: Applications and Processes
- Define intrinsic value and valuation, then explain where perceived mispricing comes from
- Explain what assuming a going concern means and set a going concern value against a liquidation value
- Set out the different definitions of value and argue which one fits the valuation of a listed company best
- Set out the uses of equity valuation
- Set out the questions an industry and competitive analysis should answer
- Contrast relative with absolute valuation models and give examples of each kind
- Explain valuing a firm as the sum of its parts and why conglomerates trade at a discount