Question

How does the Relative Valuation method work in valuing a company?

Answer 1

relative valuation model is a business valuation method that compares a firm's value to that of its competitors to determine the firm's financial worth.Relative valuation models are an alternative to absolute value models, which try to determine a company's intrinsic worth based on its estimated future free cash flows discounted to their present value.

These are collectively called “relative valuation” techniques, and consist of –

Price/ Earnings (P/E), Price/Earnings to Growth (P/EG), Price/ Book Value (P/BV), Price/Sales Ratio (P/S), Price/Cash Flow (P/CF)

The reason these are called “relative” valuation techniques is because the value of an asset here is derived from the pricing of comparable or relative assets, standardized using a common variable such as earnings (P/E), cash flows (P/CF), book value (P/BV) or sales (P/S).