Different Valuation Approaches

When valuating an asset or a company there are different approaches which can be taken. I found a blog post which talked about three different valuation approaches and what can be inferred when they derive contradictory results. The three different approaches to valuation are the following:

· Intrinsic Value: The value of the Company is the present value of its expected cash flows. You use the Discounted Cash Flow model to derive the intrinsic value.

· Relative Value: The value of the Company is based on what others are willing to pay for it. It is much simpler to use than a DCF model. An example of this is the use of P/E or P/S multiples.

· Contingent Value: The value of the Company is contingent on what happens to other assets. The option pricing model is an example of this value. Investors may invest on a small biotech company with no present revenues because they have the possibility of having high returns if the products of that company are successful in the future.

These different valuation approaches can give contradictory results. A DCF model might suggest a company is overvalued and a multiple comparison may suggest that it is undervalued. There are several inferences that can be made depending on the results of each model. When the stock is undervalued on DCF model and overvalued on relative valuation parameters, than it should be interpreted that the sector is undervalued relative to its fundamentals. Similarly if a firm is overvalued on DCF model and undervalued on relative valuation, than it should be interpreted that sector is overvalued relative to its fundamentals. Investors should look for companies that are undervalued on both the models. By this way, investors can benefit from market corrections.

http://www.thefinanceconcept.com/2011/05/equity-valuation-models-can-give.html