Get startedGet started for free

Relative Valuation

1. Relative Valuation

Now, let's recap Relative Valuation.

2. Valuation Using Multiples

In this course, you learned that relative valuation is based on the law of one price. Two stocks that look the same must have the same price. Therefore, it is crucial in relative valuation to pick "comparable" companies. Although no two companies are alike, you can use various characteristics of the company, like being in the same industry, having the same growth, risk, and profitability profile, to select reasonably similar companies. You also learned to calculate the Price-to-Earnings Ratio and Price-to-Book Ratio in the earlier chapter. These are two of the most common valuation multiples. The numerator is the market price. You can look these up on Yahoo Finance or Google Finance. The denominator can be historical or forward EPS or book value metrics. Although there is no fixed rule on which metric to use, we have to make sure that the valuation multiple and the metric we use are the same. For example, if we have a price-to-last twelve months earnings, we have to make sure that the subject firm's last twelve months earnings is used to imply its price. Do not mix historical metrics with forecasted metrics. Note that the value that results from relative valuation is an "implied" value. This means that the resulting value may be higher or lower than the quote-unquote "true value" depending on whether the market overvalues or undervalues the comparable companies.

3. Let's practice!

In the following exercise, you will be able to practice what you've learned about relative valuation. You will also practice how to combine results from the fundamental and relative valuation sections.