Relative Versus Fundamental Valuation: An Empirical Study of US Biotechnology Firms Around the 2000 High-Tech Bubble

Dzung Viet Nguyen

doi:10.5430/ijfr.v11n6p226

Abstract

This study is related to the issue of whether the stock market reflects the fundamental value of high-tech firms around the 2000 high-tech bubble. We extend the literature on firm valuation by exploiting the conceptual difference between intrinsic and relative values. We apply the residual income model and valuation multiples to estimate these two values respectively and make a comparison for a sample of biotechnology firms. Under realistic assumptions, it seems that estimated fundamental values of these firms fail to be reflected by the stock market. Their market valuation is rather based on relative value for both periods before and after the fall of high-tech stocks.

Highlights

Information needed to value a company comes from three main sources: (i) its past record and current financial statements, (ii) forecasts and (iii) comparable firms and/or competitors
We complete the literature on firm valuation by exploiting the conceptual difference between the intrinsic and relative values
The intrinsic value is derived from a fundamental valuation model with information on theoretical determinants of firm value while the relative value reflecting market trends is based on market valuation of comparable firms

Summary

Introduction

Information needed to value a company comes from three main sources: (i) its past record and current financial statements, (ii) forecasts and (iii) comparable firms and/or competitors. While the first two information sources related to financial characteristics of a company are required for estimating its intrinsic value, the third is used to provide a relative valuation. The intrinsic value of a company is the present value of cash flows that the company is expected to generate in the future, based on information currently available. The method used to estimate intrinsic value is called method of discounted cash flows. While this method provides a theoretical basis for estimating intrinsic value and on which other valuation approaches rely, the relative evaluation plays an important role in practice. The goal is not to find intrinsic value but to measure an asset based on the valuation of similar assets by the market

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Conclusion