When a security’s current market price is approximately equal to its value estimate, the security is considered to be fairly valued. Conversely, when the market price exceeds the value estimate, the security is overvalued, and so the security is undervalued…

There are three major categories of equity valuation models: present value models, multiplier models, and asset-based valuation models. Present Value Models/Discounted Cash Flow Models These models estimate intrinsic value based on expected future benefits, usually based on expected dividends (dividend…

Present value models are based on a fundamental tenet of economics stating that individuals defer consumption to reap future benefits. Therefore, the value of an investment today should be worth the present value of expected future benefits, defined as dividends…

The intrinsic value of a non-callable, non-convertible preferred stock can be calculated in much the same way as a share of common stock, except the expected sales price is replaced by the par value of the preferred shares. $$ V_0=\sum_{t=1}^n\frac{D_t}{(1+r)^t}+\frac{F}{(1+r)^n}$$…

Gordon (Constant) Growth Dividend Discount Model As the name implies, the Gordon (constant) growth dividend discount model assumes dividends grow indefinitely at a constant rate. $$ V_0=\frac{D_1}{r-g} $$ Where: \(D_1\) = expected dividends in year 1  Note that this is…

The Gordon (constant) growth dividend discount model is particularly useful for valuing the equity of dividend-paying companies that are insensitive to the business cycle and in a mature growth phase. On the other hand, multistage models are often used to…

The use of price multipliers to earnings, book value, and sales have all shown to have significant predictive value in determining relative future returns, implying that price multiples can be an effective tool for the valuation of companies. In addition,…

The concept of price multiples refers to ratios that compare a company’s share price with a financial metric, allowing for an assessment of the stock’s relative value. These ratios are commonly used by practitioners for screening purposes, identifying stocks for…

Enterprise value (EV), often viewed as the cost of a takeover, is most frequently determined as market capitalization plus the market value of preferred stock plus the market value of debt minus cash equivalents and short-term investments. EV/EBITDA EBITDA (earnings before interest,…

An asset-based valuation of a company uses estimates of the market or fair value of the company’s assets and liabilities and, thus, is most appropriate for companies with a high proportion of current assets and current liabilities and few/insignificant intangible…