THEORY OF EQUITY VALUATION

Theory of Equity Valuation



THEORY OF EQUITY VALUATION

The valuation of a business is a process through which an investor calculates the intrinsic value of a stock. (Elton, Gruber, Brown, Goetzmann 2003, Pp.51)The process of stock valuation includes understanding the basic operations of the business, analysing the working of the whole industry. In making investment in a stock, there are a numerous factors that even more multifarious than the evaluation of the stock. There are hundreds of variables that make an impact on the cash flows of the company, which are expected in future, and thus, there are a lot of factors that affect the valuation of a stock for a investor. The investors usually know majority of the variables, but they can understand a very few of them; all these variables are inter-related and independent, they are in quantifiable terms, but they are quantitative at all times, and they can impact the values of the stock. The method of discounted cash flow is the method that is used most widely in stock valuation), accordingly, the primary issue is that all investors have to face with is that how can they can use the model of discounted cash flow in the best way? And that how can they use their valuation, thorough their understanding of this model. (Benning and Sarig, 1997 Pp.45)

The model of discounted cash flow is dependent basically on two major inputs, , which is different for each investor and this is usually called the weighted average cost of capital (WACC) and the estimated future cash flow of the company, which is used by using the old financial data of the company. The result, which can be obtained from this model, is completely reliant on these two factors. The calculation of the discount factor is the major thing that creates the difference between the results, because the future cash-flows of the company will be more or less the same for every investor because they will be using the same data. (Higgins 2004, Pp.41)

In today's dynamic world, stock evaluation is becoming more and more famous among investors, who are planning to make investments in different stocks. Still the concept of stock evaluation is difficult in the current scenario because the investors are facing more obstacles and facing more risks. Therefore, each investor has its own preferences for risk and return. The different have different views about the future ...