18 Questions
Which model focuses on finding the intrinsic value of a stock?
Discounted Cash Flow (DCF) Model
What type of free cash flows are generally suitable for the DCF model?
Stable, Positive, and Predictable
Which model uses multiples like P/E, P/B, P/S, and P/CF?
Comparables Model
Why is the P/E ratio commonly used in the Comparables Model?
Due to its focus on company earnings
Which model does not aim to find the intrinsic value of a stock?
Comparables Model
Why is it challenging to predict future cash flows in a situation with negative free cash flows?
Because there is a lack of excess cash for reinvestment
What is the main purpose of stock valuation methods in financial markets?
To predict future market prices
Which type of stocks are generally purchased based on stock valuation methods?
Undervalued stocks
What is the Gordon growth model commonly used for in stock valuation?
Valuing companies that pay dividends
Which statement best describes the purpose of the discounted cash flow model in stock valuation?
To calculate the intrinsic value of a company based on financial statements
What distinguishes the comparable model from other stock valuation methods?
It values a company based on its industry comparables
Why might the Gordon growth model not be suitable for all companies?
Some companies do not pay dividends
What is the main focus of absolute valuation models?
Finding the intrinsic value based on fundamentals
Which valuation method focuses on comparing a company to other similar companies?
Comparable model
What does the dividend discount model primarily consider in its valuation process?
Future dividend payments
In which valuation model would you typically analyze cash flow projections?
Discounted cash flow model
What is the primary purpose of using relative valuation models?
Making comparative evaluations with similar companies
Which of the following is NOT an absolute valuation model?
Price-to-earnings ratio model
Study Notes
Stock Valuation
- Stock valuation is the process of calculating the theoretical value of a company or its stock.
- There are two main categories of valuation models: absolute valuation and relative valuation.
Absolute Valuation
- Absolute valuation models attempt to find the intrinsic or "true" value of an investment based only on fundamentals such as dividends, cash flow, and growth rate.
- Models that fall into this category include the dividend discount model, discounted cash flow model, residual income model, and asset-based model.
Relative Valuation
- Relative valuation models operate by comparing the company in question to other similar companies.
- These methods involve calculating multiples and ratios, such as the price-to-earnings (P/E) ratio, and comparing them to the multiples of similar companies.
Discounted Cash Flow Model (DCF)
- The DCF model is suitable for companies with stable, positive, and predictable free cash flows.
- It is typically used for mature firms that are past the growth stages.
- The model is less effective for companies with negative or unpredictable cash flows.
The Comparables Model
- This model uses multiples such as the price-to-earnings (P/E), price-to-book (P/B), price-to-sales (P/S), and price-to-cash flow (P/CF) ratios to compare the company to its peers.
- The P/E ratio is the most commonly used multiple, as it focuses on the earnings of the company, a primary driver of an investment's value.
- This model does not attempt to find an intrinsic value for the stock like absolute valuation models.
Test your knowledge of stock valuation methods, including multiples approach, absolute valuation, and relative valuation. Learn how to choose the right method for analyzing a firm's value in the market.
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