Valuation Method: Relative Valuation Technique

                                                       

Valuation techniques are one thing which every investor should have grip on. If not expert, then one should at least have the basic know how of the topic so that they may evaluate their options when making investment decision. At the point of investment there is range of assets available among which there are various kinds of options so it gets quite difficult to calculate opportunity cost. Valuation techniques can be categorized into absolute or intrinsic value or relative valuation. Both of the approaches are valuable. Relative valuation is comparing prices of two assets having same properties trading in the market whereas through absolute value we find the true value of asset by calculating its net present value.

Let’s talk about relative valuation stocks 101 in particular to explain its usage in terms when and how it should be used. As mentioned earlier relative value of an asset is found through comparing variables of a similar asset, for example when buying smart  phone, one can compare prices of similar smartphones available in the market, having same properties and functions. Same goes for the stocks, we compare its price, earnings, and company revenues from the other stock trading in the same sector, industry or index. There are certain valuation multiples which come handy when using relative valuation for choosing a stock such as price to earnings multiples, price to book ratio, price to sales ratio, or even revenue multiples etc.  

The key steps in doing relative valuation starts with finding comparable for your stock that is appropriate to relate with. That is a stock of an oil company can best match with the stock of another oil company trading in the same sector. Second step is to standardize the comparable that is companies vary in size and revenues they earn so it should be standardized against certain variable such earnings per share. Third and last step is to mitigate any difference arises even after standardization. Putting it in simple words, let’s say the price to earnings multiple for Tesla Motors is way higher than Ford Motors and industry average. There could be many reasons attached to it which can be analyzed by analyst depending on their predictions, valuation and expertise.

So all in all this how relative valuation is used, it will be further elaborated in the next posts, till than enjoy valuing your assets.