What is a ‘Valuation Analysis’
A form of fundamental analysis that looks to compare the valuation of one security to another, to a group of securities or within its own historical context. Valuation analysis is done to evaluate the potential merits of an investment or to objectively assess the value of a business or asset.
Valuation analysis is one of the core duties of a fundamental investor, as valuations (along with cash flows) are typically the most important drivers of asset prices over the long term.
Explaining ‘Valuation Analysis’
Valuation analysis should answer the simple, yet vital, question of, “What is something worth?” The analysis is then based on either current projections or projections of the future. While investors can agree on a metric like the current price-to-earnings ratio (P/E ratio), how to interpret a given valuation can and will differ among those same investors.
Many types of valuation methods are used, involving several sets of metrics. For equities, the most common valuation metric to use is the P/E ratio, although other valuation metrics include: Price/Earnings, Price/Book Value, Price/Sales, Enterprise Value/EBIDTA, Economic Value Added and Discounted Cash Flow.
Further Reading
- Economic valuation of the environment – ideas.repec.org [PDF]
- Corporate governance and market valuation in China – www.sciencedirect.com [PDF]
- Risk and valuation of collateralized debt obligations – www.tandfonline.com [PDF]
- Ratio analysis and equity valuation: From research to practice – link.springer.com [PDF]
