Deciding the proper valuation method to value a stock can be an overwhelming experience. Some can be fairly straightforward, others can be quite frustrating. But, independently of their complexity or simplicity, no valuation method is always entirely correct. Each stock is different, and each industry has unique attributes. When analyzing an investment, you may need multiple valuation methods.
Below, we discuss the most popular methods of stock valuation.
1. Dividend Discount Model
The Dividend Discount Model, or DDM, is one of the simplest stock valuation methods. It assumes that a company’s value is represented by the dividends it pays to its investor. In essence, the intrinsic value of the company is defined as the present value of future dividends to investors.
2. Discounted Cash Flow Model
The Discounted Cash Flow model – or DCF – is another standard method of stock valuation. Under this approach, the intrinsic value of a company is related directly to the free cash flow it will generate. As such, it can be applied to any company that does not have a predictable dividend distribution. Nonetheless, it is ineffective when analyzing young companies that are yet to become cashflow positive.
3. Comparable Companies Analysis
Comparable Analysis, or Multiples Analysis, differentiates from DCF and DDM, as it focuses less on companies’ fundamentals. It instead compares several companies to compute their respective overall intrinsic value. It does so by using multiples, the most common of which are P/E (price-earning-ration) and EV/EBITDA (enterprise value-to-EBIDTA). Although it is relatively straightforward and can be applied to companies that are cashflow negative, it can be challenging to find good comparable companies.