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Valuation Methods
When it comes to the valuation of equities, there are three different methods that are commonly used. These three methods are the dividends valuation method, the free cash-flow method and the market-based method. As one might expect, there are pros and cons to each approach. As such, a proper compare and contrast of what is better in what ways and what is potentially inferior in other ways can and should be ventured into. Of course, there would be advantages and disadvantages to all three methods and this would thus lead to one method being favored in a given situation, for whatever reason. While the perceived outcomes and such would be different for each method, the proper method of valuation should be chosen based on the situation and the perspective/needs of the company or person doing the evaluating.
Analysis
When it comes to the free cash flow method, this involves a simple analysis that is used to predict and project what is likely to happen in the near future. Indeed, ascertaining whether a company will soar or fall in terms of value is the way in which people make money. People that guess right are rewarded for their investment while people that guess wrong have to go back to the drawing board....
One of the main methods is known as the operating free cash flow method. This is based on the cash that is generated by operations. This cash flow is then attributed to all of the relevant providers of capital when it comes to the firm's overall capital structure. This would and should include both funders and debt providers to the same situation. Generally speaking, the operating free cash flow is figured by taking the earnings before interest and taxes and then adjusting for the tax rate. Depreciation is added and capital expenditure is subtracted from this figure. There is also the subtraction of working capital change and changes in other assets. The figure that is then garnered is the free cash flow for a firm. This, in combination with the growth rate, is seen as one of the primary ways to see what direction a firm is going in. This can be a good indication, so this would be an advantage. The downside is that there are other metrics and details that could and should be taken seriously when it comes to equity valuation (Cherewyk, 2011).
When it comes to the…
References
Cherewyk, P. (2011). Valuing Firms Using Present Value Of Free Cash Flows. Investopedia.
Retrieved 7 September 2016, from http://www.investopedia.com/articles/fundamental-analysis/11/present-value-free-cash-flow.asp
Tarver, E. (2015). What are the advantages and disadvantages of the Gordon Growth Model?.
Investopedia. Retrieved 7 September 2016, from http://www.investopedia.com/ask/answers/032415/what-are-advantages-and-disadvantages-gordon-growth-model.asp
valuadder.com. Retrieved 7 September 2016, from http://www.valuadder.com/valuationguide/business-valuation-market-approach.html
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