Question

discuss with examples the three steps valuation approaches for equities

Answer 1

Equity valuation is done to estimate the value of a firm’s securities. It’s determined to know the quality and potential of equity. External factors also influenced the value equity and its return.

Three steps valuation approaches for equities are as following:

Economic Environment: - The economic environment of a country has a significant influence on the industry as well as the firms. The fiscal and monetary policies of any country directly influence the value of any firm’s equity which operates in the country. Any change in taxes or interest rate will have a direct impact the consumer spending and firm’s financial decisions.

Example: A Cigarette selling company will get impacted if government impose taxes more on Cigarette. And it will negatively impact the value of the firm. As the price of a product will increase and consumer spending will reduce.   

Industry Environment: - Industry in which a firm operates also influenced the value of a firm. There are standard of various industries on which an organization can measure its value with the predetermined standard. This will give the exact value of firm’s equity in the industry. The existence of competitor also influenced the value of the firm.

Example: liquidity of a firm can be measured by the comparison of the firm’s current ratios to the standards of the industries. This will give the liquidity position of an organization. A standard current ratio is 2:1, if a company has low ratio it means it has less current assets to pay its current liabilities. Type and nature of industry also play a vital role in firm’s valuation.

Company Environment: - After forecasting economic and industrial environment it’s very important to have adequate knowledge about the firm fundamentals before making any investment decision. Financial performance of various assets of affirms over a period of time gives an insight of firm’s equity value.

Example: Ratio analysis gives an exact value of a firm’s equity value. And also an insight how all the assets performed over a period as well as compared their performance with industry.

These three steps give the exact value of equity. This is very important for any investor before making an investment decision. By understanding economic, industry and firms environment it’s easy to get the present value of equity, and helpful in future prediction value of equity.