The valuation of shares is an essential element in the practice of value investing, since it serves to determine whether or not the shares are undervalued, indicating whether we should buy or sell. In this article we will see the four most used stock valuation methods in practice by value investing professionals.
Intrinsic value, the purpose of valuation
The intrinsic value of a financial asset is defined by safety margin”Of which we have already talked in this blog.
The basic stock valuation methods
There are different methods of valuing a company, with different levels of sophistication and different characteristics. It can be said that there are 3 main methods or approaches for valuation:
- Valuation through discounted cash flow (“DFC”, “discounted cash flow” or “DCF”): The value of an asset is equal to the present value of its future cash flows.
- Valuation based on equity value ("book value" or "book value"): The value of the share will be that of its assets minus its liabilities, that is, what it has less what it owes, without taking into account its income futures.
- Relative valuation: The value of an asset is established by comparing it with other similar assets, using variables such as profits, cash flows, book value or sales, among others.
- Valuation through real options (“real options”): The value of an asset is determined through the use of option pricing models. The best known is the Black and Scholes model, for which they won a Nobel Prize in economics. However, there are other simpler ones that can be more useful in the valuation process.
In future articles we will analyze the stock valuation methods in greater depth, with their pros and cons, studying which is the most suitable method to use in each case.