ABC Of Valuation
What is it?
Valuation is defined as the process of determining the current worth of an asset or company and is an indispensable aspect of investment.
A company’s valuation is done on grounds of its business management, composition of capital structure, prospect of future earnings, and value of its market assets. An asset on the other hand is valued keeping in consideration its book value, and absolute valuation models like discounted cash flow analysis, option pricing models or comparable.
An integral point of investment in company stocks is examining the intrinsic and market values of a company. While intrinsic value is an estimate of the true value, the market value is the current value of a company based on the price of its stocks. Analysing the difference between the two is where valuation comes into the picture. Over-valuation implies that the market value is higher than the company’s intrinsic value and under-valuation means that market value is less than its intrinsic value.
1. Crucial factors for measuring stock valuation are:
A. EPS: Earnings Per Share is an indicator of company’s profit and thus profitability of a share since more the more earnings a company can generate per share is an indicator of how much the share pays to its holders.
EPS= Earnings available to shareholders ÷Number of shares outstanding
B. P/E Ratio: Price to Earnings ratio calculates how expensive a stock price is as compared to its earning produced per share.
P/E Ratio= Market price per share ÷ EPS
C. EBITDA: It stands for Earnings Before Interests, Taxes, Depreciation, and Amortization. EBITDA is a company’s net income with tax, interest, depreciation, and amortization expenses added back.
2. Approaches to Valuation:
A. Income Approach: This approach values a company based on the amount of income a company is expected to generate.
It has two types:
(a) Capitalization of Cash Flow Method: It takes a single benefit scheme and assumes it grows steadily into perpetuity. This method is most beneficial when a business is expected level of stable margins and growth in the future.
(b) Discounted Cash Flows Method: It is based on the concept that the value of a business is equal to its present value of its projected future benefits. It is used when future growth rates or margins are expected to vary.
B. Comparable Company Analysis: It looks at similar companies, in size and industry, and how they trade to determine a fair value for a company or asset.
C. Past Transaction Model: It looks at past transactions of similar companies to determine an appropriate value.
D. Asset Based Method: It adds up all the company’s asset values, assuming they were sold at fair market value, and to get the intrinsic value.
E. EBITDA Valuation Method: This method relies on a multiple of EBITDA to assess the company enterprise value. The value of the multiple is based on comparable actual sales transactions occurred recently in the company’s industry.
Stay tuned to our page for further detailed methods of valuation.