Question

The authors of the paper “What Valuation Models Do Analysts Use” state: … contrary to our expectations, some analysts who construct explicit multi-period valuation models still adopt a comparative valuation model as their preferred model. Describe the differences in the two approaches and explain why an analyst would prefer a comparative model.

Answer 1

The multi-period valuation model involves making different assumptions about the growth and performance of the firm for different periods and then discounting the resultant cash flows by using an appropriate discount rate. It is different from the comparative valuation model because in that, we simply compare different firms in the industry the firm is operating in, take average of the unlevered valuation multiples and assume it to be the multiple of the target firm by releveraging. Hence, it doesn't involve so many assumptions to be made by the analysts. The valuation multiples are also easier to obtain compared to deciding the growth figure (in percentage terms) of the firm's sales in different periods and they are also difficult to justify. These are the main reasons why analysts prefer the comparative valuation models.