Respond to each classmate 100 words a piece.
Individual investors and professional analysts uses various valuation approach to evaluate common stocks but the frequently used is the valuation derived from the dividend discount model (DDM), which applies the discounted cash flow principle to the dividends expected to be received from investing in a stock (Besley, S., & Brigham, E., 2015, page 710). Industry practitioners use three main valuation approach in valuing a company namely; DCF analysis, comparable company analysis, and precedent transactions. Also, investment banking, equity research, private equity, corporate development, mergers & acquisitions (M&A), leveraged buyouts (LBO), and most areas of finance uses the three main valuation methods frequently.
In valuing a business or asset, three methods could be used.
- A cost approach is used to evaluate the estimate needed to rebuild or replace an asset. It is commonly used in real estate, such as commercial property, new construction, or special use properties.
- A form of relative valuation which includes comparable analysis and precedent transactions is the market approach, which is used frequently in the industry.
- The most detailed and thorough method to valuation modeling is the discounted cash flow (DCF) approach, which is a form of intrinsic valuation.
Comparable company analysis (also called “trading multiples” or “peer group analysis” or “equity comps” or “public market multiples”) is used to compare a company’s current value to other similar businesses by taking into consideration trading multiples like P/E, EV/EBITDA, or other ratios. Its advantage is when a highly comparable group is available, both size and business type would be compared. One notable disadvantage is the whole sector may be over or undervalued.
Discounted cash flow (DCF) analysis is a built-in value approach system that predict a firm’s future uncovered free cash flow and discounts it back to today at the firm’s weighted average cost of capital (WACC). An advantage is easy comparison of competing opportunities, while the disadvantage is calculating interest rates in the future is unknown.
Another form of relative valuation is the precedent transaction analysis, where a current company is compared to other similar businesses that have recently been sold or acquired in the same industry. The take-over premium transaction values are included in the price for which they were acquired. An advantage of precedent transaction analysis is its ability to take into account all the underlying values in the firm’s assets. The disadvantage is that it does not favor small firms. The strength of the various valuation methods should be maximized and its weaknesses minimized.
The valuation method is regarded as an important aspect of analyzing a business’s capability and its ability to affect the market value of the business. It is understood by many as the process used in determining the fair market value of a business. The common valuation methods are the income approach, market approach, and asset-based approach.
The business valuation includes the worth of equipment, inventory, property, liquid assets, and anything of economic value and importance owned by an organization. The management structure, project earning, share price, and revenue are vital elements of the valuation method. This system can be used ineffectively by maximizing its strengths and minimizing its weakness.
The first is the comparable analysis valuation method, which provides a detailed value for a business on what the organization is worth. This system provides a business with what the company is worth. It gives an observable value for business on what each company is worth. Its advantages are easy to use, and it is based on real and accurate data. The disadvantages are Less accurate for thinly traded stocks or volatile companies and there may not be truly comparable companies.
Precedent transaction analysis is a type of valuation method where a business is compared to other businesses. It includes the price that they were purchased. It provides a solid guideline for a detailed analysis. The advantages are based on what real companies paid to other companies; it is easy to perform as long as data is available. As for the disadvantages, data can be spotty, there may not be truly comparable transactions.
Discount cash flow is a valuation method that forecasts a business’s cash flow and spending habits. It allows the analyst to forecast the business future of an organization. The advantages are unique because the free cash flow is trustworthy and it tracks the money left over for investors. As for the disadvantages, it has no effect on fast-growing companies, which can sometimes be unpredictable.