RELATIVE VALUATION

DEFINITION
According to Capital Com Bel, Relative Valuation is a process of comparing an asset with
other assets to determine its value, also known as comparable valuation.

The relative valuation compares the value of an asset to the values assessed by the market for
similar or comparable assets. By assessing what the market is paying for comparable assets,
relative valuation generates a judgment on how much an asset is worth.

In addition, according to True Tamplin, the founder of Finance Strategists, the method
assumes that relative values will rebound to a mean over period due to a historical link among
investments. As a result, relative value is frequently utilized as a relatively long method reported,
with variations values taking up to several weeks to see.

A relative value is an important way for investors to identify the relative performance of one market
in comparison to another, and it may be especially useful when buying stock indices because
price swings are most often identical.

Relative value is particularly essential since it allows entrepreneurs to purchase in assets that
would otherwise be overlooked since they are comparatively inexpensive in comparison toward
other assets.

FUNCTION OF VALUATION
A relative valuation model is a business valuation method that assesses a company's
financial worth by comparing its value to that of its competitors or industry peers by comparing
the current value evaluated through trading multiples like P/E, EV/EBITDA, or other ratios.
Valuation can be defined as the process for finding the ‘value’ of anything. In the world of finance,
value of anything (tangible or intangible) would be reflected by the price that potential buyers and
sellers agree to conduct the transaction for the transfer of ownership, which may obviously change
with time. The demand and supply for are the drivers of the process of ‘price discovery’ of any
asset in any market.
A transaction for transfer of ownership of any asset is possible only when there is an overlap
between the two price ranges as shown below:

• Zero to maximum price that any potential buyer is willing to pay (say PB,Max)
• Minimum price that any potential seller is ready to sell at to infinity (say PS,Min)

For potential buyers, valuation is the process of finding the threshold Maximum price that any
potential buyer is willing to pay. On the other hand, for potential sellers (owners of the asset),
valuation is the process of finding the threshold Minimum price that any potential seller is willing
to sell the asset at.

But how would anyone find these thresholds?

 One of the key methods is to conduct discounted cash-flow (DCF) analysis, which is based
on the principle of time value of money. In this method, future cash-flows which may be potentially
earned from the asset are projected and are discounted at a rate corresponding to the perceived
risk to find the present value. However, DCF is a reasonably time-taking process and needs
special skills such as financial modeling and in-depth knowledge. In case of equities, projection
of future cash-flows is even more challenging given the ever-changing business scenarios,
emerging strategies, evolving technologies and unpredictable consumer behavior. This is
when Relative Valuation comes to the rescue, to a certain extent. Relative Valuation is the
process of comparing certain characteristics and parameters (e.g. financial ratios, growth rates
etc.) with those of similar other assets to derive the price of the asset.
Relative valuation is a much quicker process and certainly helps when as an investor you
want to screen and shortlist the stocks for building the consideration set of potential investments
or for finding if an existing investment of yours is over-valued compared to its peers and should
be sold off.
To be able to use Relative Valuation skillfully, one needs to be able to pick the appropriate
ratios for comparison, understand financial statements and be able to normalize various ratios
through adjustments.

PROCESS/STEPS IN VALUATION
• The first step is identifying comparable assets and corporations. These are the size,
nature, growth, margin, and risk. Market capitalizations and revenue or sales data can be
relevant in these situations. Their stock prices reflect how comparable companies are
valued in the market at any time.
• Have annual reports, direct discussion with the company about share price data, market
and industry data.
• Choice of multiples. Using these basic figures to calculate pricing multiples. Price multiples
might include ratios like the price-to-earnings (P/E) or the price-to-sales (P/S) ratio.
• Comparing these multiples to those of a company's peers or competitors to see if the stock
is undervalued in comparison to others.

ADVANTAGES OF USING RELATIVE VALUATION

• Capability to apply various valuation ratios that can output a complete picture on the true
value of a security within a given industry. It provides the capability of comparing a
company's performance with those of the broader market and its primary competitors.
• Power to value a company without accessing proprietary data, in example is when
comparing the value to public companies or previous transactions within private markets.
• Can be conducted through simple observation techniques by the wider public and brokers
especially when about considering the stock markets.
• Learning how to use relative valuation will give benefit to find the value of the company
wherein the company can use it as a basis to compare your other forms of valuation, such
as a discounted cash flow to see if your story is off compared to the market.
 • Valuation is a matter of judgment, and multiples give a framework for evaluating values.
Valuations, when utilized appropriately, are complex instruments that may give valuable
insight into how related assets are priced in the market.
• Its straightforward and effective numerical technique increases communication with
consumers or clients. The conclusion is basic and uncomplicated since the approaches
are transparent, simple to grasp, and comprehensive.
• Relative value modelling captures the current market condition and price. For certain
investors, such as investment companies or stock market analysts, the current market
price may be more valuable than the inherent value of the company's cash flows. Because
their performance can be compared to a market index or a price, the relative valuation
approach can be more beneficial.

DISADVANTAGES OF USING RELATIVE VALUATION

Limitations. Like any valuation tool, relative valuation has its limitations. Although relative
valuation is popular, it is still having its disadvantages. First, unlike a discounted cash flow
valuation, a valuation based on a multiple and comparable firms may be conducted with
significantly fewer assumptions and much faster. Indeed, relative valuations are more likely to
produce values that are closer to the market price than discounted cash flow estimates. Relative
valuation is a significantly faster procedure that can help an investor screen and select stocks for
establishing a consideration set of new investments OR determine if an existing investment is
overvalued in comparison to its peers and should be sold. The assumption that the market has
correctly valued the firm is the most significant constraint. It may not matter if one has a lower P/E
or a higher return on equity if both Visa and MasterCard are trading at nosebleed levels.

Unfortunately, there are also limitations to relative valuation processes with some
contending that it is impossible to get a clear picture of a company’s value without analyzing its
intrinsic financial. Other disadvantages include:

• They are backward looking and historical, which is not always an indication for future
performance
• Can be based only on external observations that may be misleading
• Companies can potentially manipulate certain ratios to appear to be performing better
than they are
• There is a potential to over-value some industries which could result in a bubble

Relative valuation's advantages are also its disadvantages. First, the ease with which a
relative valuation may be constructed by combining a multiple and a set of comparable enterprises
can lead to inconsistencies in value estimations when essential characteristics such as risk,
growth, and cash flow potential are overlooked.
SOURCES
True Tamplin. (2021, November 24). What Is Relative Value? Retrieved from
https://learn.financestrategists.com/finance-terms/relative-value/
Capital Com Bel. (n.d.). Relative Valuation. Retrieved from https://capital.com/relative-
valuation-definition
SourceScrub. (2021, September 14). Relative Valuation Definition. Retrieved from
https://www.sourcescrub.com/post/relative-valuation-definition

https://www.investopedia.com/terms/r/relative-value.asp
https://einvestingforbeginners.com/relative-valuation-daah/

https://www.sourcescrub.com/post/relative-valuation-definition
https://www.edupristine.com/blog/importance-relative-valuation

http://pages.stern.nyu.edu/~adamodar/pdfiles/DSV2/Ch4.pdf
https://einvestingforbeginners.com/relative-valuation-daah/

https://www.investopedia.com/articles/stocks/11/relative-valuation-stocks-valuing-
stocks.asp

GROUP 1
ABALOS, ANGELA NICOLE

BANTILAN, DENICE TEOFILA

DUGAYO, ALLLANA ERICKA

DURA-OG, MICA

LIGON, DANA

LOREMIA, MARIEL

PAGLINAWAN, SHAIRA

PURIFICACION, GLAZE

TAY, JASHIEL