Methods for valuing a company

Description

Need help with the following questions.  Each question needs it’s own answer and it’s own reference.

q1.  There are actually at least three methods for valuing a company the DDM and discounting cash flows and valuation by comparables, described below.  Which one do you think makes more sense in practice?

Valuation by comparables:

We talked a lot about the DDM and FCF models but the most commonly used method of valuation is actually “by comparables”.  This method uses financial statements and market comparables to estimate firm value.

One approach to firm valuation is to focus on the firm’s book value, either as it appears on the balance sheet or adjusted to reflect the current replacement cost of assets or the liquidation value.

Stock market analysts devote considerable attention to a company’s price–earnings ratio.  The P/E ratio is a useful measure of the market’s assessment of the firm’s growth opportunities.

Firms with no growth opportunities should have a P/E ratio that is just the reciprocal of the cost of equity, k. As growth opportunities become a progressively more

important component of the total value of the firm, the P/E ratio will increase.

Many analysts form their estimates of a stock’s value by multiplying their forecast of next year’s EPS by a predicted P/E multiple. Some analysts mix the P/E approach with the dividend discount model. They use an earnings multiplier to forecast the terminal value of shares at a future date and add the present value of that terminal value with the present value of all interim dividend payments.

q2.  What is an asset back security?

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