Relative Valuation Model
Candlefocus EditorThe P/E ratio, one of the most commonly used multiples, compares the company's share price to its earning potential for a certain period of time. For example, if a company is trading at a P/E ratio of 5, it means that the investors are valuing the company at $5 for every $1 of earnings. This method is often used to gauge how the market perceives a company and to identify over- or undervalued stocks.
Enterprise value (EV) is another popular multiple used in relative valuation models. EV measures the value of all outstanding shares, minus any associated cash or debt, and works to match up a company's worth with that of its peers. EV is a more accurate measure of a company’s worth when compared to market capitalization, as it takes into account a company’s market capitalization, debt, and other non-equity liabilities.
Relative valuation models can be used to determine the estimated value of a company by comparing it to the industry average or to its competitors. This type of valuation is useful because it will take into account a variety of indicators, such as the company’s P/E ratio, EV and other multiples, to help the analyst determine the company’s value relative to others in its industry.
Relative valuation models can be useful for investors and analysts as they help provide a means of comparing a company’s worth within its sector or industry. These models can be used by analysts and investors to assess whether a company is over- or undervalued. Relative valuation models are one of the cornerstones of any financial analysis and should always be considered when making an investment decision.