Applied Equity Valuation: Relative Valuation Method

Abstract

The primary alternative valuation method is relative valuation. Relative valuation involves the use of multiples (ratios) that have “price” as the numerator and a “cash flow–generating performance measure” for the denominator and that are observable for other “similar” or like-kind firms. In using relative valuation, we assume that we can find comparable firms that are in the same risk class as the firm we are attempting to value and that the observable market clearing price for the comparable firms is a fair price. As with the discounted cash flow method, the relative valuation method requires strong assumptions and expectations about the future. No one single valuation model or method is perfect. All valuation estimates are subject to model error and estimation error.