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Relative Valuation

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Key Highlights

  • Relative valuation is a way to figure out how much a company or its shares are worth by comparing them with similar companies in the same industry, using key numbers like profits, sales, or stock prices.

  • Unlike absolute valuation, which focuses on a company's intrinsic value based on its own fundamentals, relative valuation relies on market-based comparisons to assess whether an asset is overvalued, undervalued, or fairly priced.

What Is Relative Valuation?

Relative valuation is a way to figure out how much a company or its shares are worth by comparing them with similar companies in the same industry, using key numbers like profits, sales, or stock prices.

Unlike absolute valuation, which focuses on a company's intrinsic value based on its own fundamentals, relative valuation relies on market-based comparisons to assess whether an asset is overvalued, undervalued, or fairly priced.

Key Features

  • Comparison-Based: Values an asset by benchmarking it against peers using standardized financial ratios or multiples (e.g., P/E, EV/EBITDA, P/B).

  • Market-Driven: Reflects current market sentiment and pricing trends, providing a real-time perspective on value.

  • Widely Used: Common in equity analysis, mergers and acquisitions, and investment decision-making due to its simplicity and accessibility.

How It Works?

  • Identify Comparable Assets: Look for companies that match in size, belong to the same industry, and run their business in a similar way.

  • Gather Market Data: Collect market prices and relevant financial data for the target and comparables.

  • Standardize Metrics: Use financial ratios (multiples) to normalize values for comparison (e.g., price-to-earnings, price-to-book).

  • Analyze and Adjust: Compare the target's multiples to peers, adjusting for differences in growth, risk, or accounting methods.

Advantages of Relative Valuation

  • Simple and quick to apply.

  • Uses readily available market data.

  • Reflects current market conditions and sentiment.

Limitations of Relative Valuation

  • The results will only be reliable if you choose companies that are truly similar.

  • Can be distorted by market bubbles or manipulated financial ratios.

  • Relies on historical data, which may not reflect future prospects.