In a previous article we saw the main methods of calculating the equity value that we use in value investing. The equity value is a good starting point for fundamental analysis. However, in most cases it must be supplemented. In this article we will analyze if equity valuation is sufficient to obtain the intrinsic value of a company and when it should be complemented with other methods of valuation of companies.
Is the equity valuation sufficient to determine the intrinsic value of a company?
Sometimes, the equity valuation can be enough to determine the value of a company. However, this is usually the exception. In fact, the normal thing is that the book value of quality companies is much higher than their equity value.
What is this about?
There is something that I have not told you about the company that I have used as an example in the article on equity valuation methods. This company, which is listed on the Spanish stock market, is none other than capitalization bursátil of Inditex, that is, the value of the company on the stock market, is much higher:
Market capitalization at time of analysis: more than € 95.000 billion
How is such a big difference possible?
Why are these huge differences between equity value and market capitalization due?
The equity value should be, in principle, a starting point in the valuation process when we analyze companies in which we plan to invest. However, companies often have a capitalization and intrinsic value greater than the value of their assets.
What is this about? This is because the value of a company tends to go beyond the value of its assets, since its value is usually more influenced by the future benefits it generates for its shareholders than by its equity value.
So, is the asset valuation useless?
Yes, it is worth it, but its importance is relative, since it will depend on each type of company.
For example, in a company in liquidation, the equity valuation will be the method on which we base ourselves when calculating the intrinsic value of the company, since the value of the company will be determined by the money that the company will generate after the selling your assets after paying off your debts after deducting your settlement expenses.
On the other hand, in companies that generate increasing profits, the equity valuation will have a relatively low importance, since the value of the company will come from its ability to generate free cash flows for its shareholders.