Stock valuation

[Fernando Palmer]

In layman terms, could you please explain to me the difference between the absolute and relative stock valuation methods?
 

[Rishabh Tyagi]

Absolute valution

- Focuse on finding the real or intrinsic value of the stock. It mainly consideres fundamental factors.

- The aim is to derive the actula worth of the compny in present, and estimate the future cash flow of the company. 

There are several methods; 

• Discounted Cash Flow (DCF) - involves estimating the future cash flows generated by the company and discounting them back to their present value.
• Dividend Discount Model (DDM) - estimates the value of a stock by summing up the present value of its expected future dividends.
• Earnings-Based Models - uses multiple ratios to determine the stock's value relative to its earnings or other financial metrics like Price-to-Earnings (P/E) ratio, Price-to-Sales (P/S) ratio, or Price-to-Book (P/B) ratio.

Relative Valuation

- This menthod comapnre the stocks with other simal stocks or industry or becnhmanrks. It is focused around how the stocks if placed relative tp other similar stocks. 

- Some common methods include; 

• Price-to-Earnings (P/E) Ratio - it helps in evalutoing the valution of the stock, whether it is overvalued or undervalued. It compares a company's stock price to its earnings per share (EPS).
• Price-to-Book (P/B) Ratio - compares a company's stock price to its book value per share. 
• EV/EBITDA Ratio - compares a company's enterprise value (EV) to its earnings before interest, taxes, depreciation, and amortization (EBITDA).

[AlexMercer]

Hi Fernando, thanks for your question. 

The difference between the absolute and relative valuation methods is the same as the difference between absolute and general in any context. The absolute method looks at stock and it’s 100% focused on the stock only. Analysts focus on earnings, revenue, market performance, future outlook, etc. 

Contrarily, relative valuation tends to compare the stock with other stocks within the same industry. Hence, analysts wouldn’t be only looking at Facebook, but also at other tech giants from the same sector e.g. Twitter. This way, they compare market performance, earnings per share, price to earnings ratio, etc., to identify best investment opportunities and stocks that are undervalued by the market.