What is Equity Valuation?
Equity valuation is simply another term for how much your shares in a company are worth at that point in time. Essentially, notes Fintalent’s equity valuation consultants, it is a process of estimating the value of a company’s equity stake by using comparables and other metrics. Companies use these calculations to determine how much their stocks will sell for on the open market or how much they should offer another company when making an acquisition offer.
A company’s stock is also used to pay dividends and is one of the primary ways to finance the company (the other being debt). For public companies, lofty stock prices are used to bail out management when it becomes necessary. It’s also a great “selling point” for investors who want to buy stock in the company hoping that it will go up. Even after all these potential uses, equity valuations are still considered only a part of the overall valuation process to determine how much companies are worth in value.
Using comparables helps companies estimate the value of their business. For example, a company may see that the price of another company’s stock is equivalent to the current stock price. A valuation analyst can then compare that price to a set of factors calculated using data on comparable companies. These comparisons are used to determine how much cash a company could get if it sold its equity to another company, called a “sale multiple.” The sale multiple is just another way of saying how much a company is worth — basically, when you sell your equity stake to another company, you’re selling for a certain price.
Another method of equity valuation uses discounted cash flows or DCF. In this case, the analyst will estimate how much cash the company generates every year and how much cash it generates in the long run. This method is more accurate for companies that generate a significant amount of yearly revenue.
Valuation is extremely important to businesses and investors alike. If an investor doesn’t know what a business is worth, he or she doesn’t know what they can sell their stock for at a later date if they want to sell their shares or if they should buy more stock when that stock trades at a lower price on the open market.
Why Should I Care?
Knowing the value of your shares helps in a number of ways. Firstly, it’s an important aspect in investment decision making such as when you’re thinking about selling your shares. Secondly, it can help you to monitor how well the company is performing and how it compares to other companies in its industry.
How Do I Go About Finding the Value?
The best place to start is checking out the latest financial reports which will give you up-to-date figures on things like earnings per share, dividends paid and even how much cash is sitting in the bank.
How is the Value Calculated?
There are a number of ways in which this value can be calculated but we’ll look at the most common ones.
The Book Value per Share
Book value per share is simply the value of what the company owns (assets) less what it owes (liabilities). This is often referred to as “Book” or “BV” and is a good indicator of how much cash a company has on hand, but also how much they’re spending when they do need to pay their bills.
The GDV Method
The Growth Based-Value (GDV) method is a more complex way of valuing a company. In short, it involves comparing the company’s earnings per share to the growth rate in those earnings over the previous 5 years. If the growth is low or negative then you can conclude that there’s undervalue. This means that the value of your shares will be lower than they should be, which might make them a good bargain.
The Discounted Cash Flow Method
Sometimes referred to as DCF, this is another way in which you can calculate equity valuation. It involves examining the amount of money that a company will earn in future years and then determining how much of that money you’re likely to see returned as cash. The discounted cash flow method is a particularly useful way to do this as it discounts the value of future earnings by the interest rate level. This therefore gives a more realistic figure for what investors can expect to receive as they’ll also have to pay interest on borrowed funds, reducing their return on investment.
Overall, one of its strengths is that DCF provides estimates that are reliable with very little imprecision (error). In fact, it allows comparisons between firms of different sizes based on their past performance when only limited information is available about them.
DCF also provides an estimate that can be compared with market values, which is its biggest advantage. The market value of a firm is the share price multiplied by the number of shares outstanding. It is what investors are willing to pay for their tickets to that particular show.
DCF estimates can be used:
- As entry and exit prices for current investments
- As benchmarks in order to evaluate performance
- To create investment strategies or
- As a valuation method for new acquisitions.
In conclusion, equity valuation is simply how much your shares are worth at that particular moment in time. This can be a useful tool to develop a picture of how well a company is doing and if it’s worth investing in or selling.