Valuation is the name given to the analytical process of determining the present (or protected) value of the asset holdings of a company or an individual. The valuation of a company can be found in many ways. An analyst uses the business management of the company, its capital structure’s composition, the market value of its assets, and the prospective future earnings through business and investments to reach an appropriate valuation. There could be other domain-specific matrices that can be used to determine the valuation of a company.
Fundamental analysis is the commonly used method to calculates valuation. Other methods of finding valuation include the Dividend Discount Model (DDM) or the Capital Asset Pricing Model (CAPM).
The valuation is a useful tool to determine the value of the security, which is determined by what a potential buyer is willing to pay to the seller in a transaction. When these securities are traded on an exchange, the market value of a bond or stock is determined by the buyer or seller. However, there is also a term called intrinsic value which refers to the perceived value of the security calculated on the perceived future earnings or any other unrelated attribute of the company related to the security. This is where valuation becomes important as analysts can run algorithms or use other analytical tools to assess whether an asset is overvalued or undervalued.
Relative Valuation models operate by comparing the assets of the company with other similar companies operating in a similar business and having similar assets. The employed methods are calculating ratios or multiples like price to earnings multiples and then using them to compare with multiples and ratios of similar companies. This is a relatively easier method to compare whether the company is undervalued or overvalued and thus, many analyst and investors use this method.
The Absolute Valuation method in comparison uses the intrinsic or true value of the asset to calculate its market values. The method is based on fundamentals such as cash flow, dividends, and the growth rate of the company. The valuation models of this category are discounted cash flow models, the dividend discount model, and the residual income model.
The EPS or earnings per share formula is quite famous among investors financial market experts. It states that earnings available to the common shareholders divided by the total number of the outstanding common stock shares give EPS ratio. It is an indicator of the profit of the company as the more profit a company can generate per share the more is the value brought by each share to its holder. The other method is the price to earnings or P/E ratio which considers the ratio of the price of a share divided by earnings per share. This ratio gives an estimate of how expensive a stock is compared to the earnings produced per share.
“For example, if the P/E ratio is 20 the analyst will compare this ratio with other companies operating in the same industry and with the ratio taken for a broader market.
Thus, we can see that the different ratios change with changing earnings of the company’s share and so earnings are also an important indicator to estimate the fair value of a company.
Valuation has its own limits like other mathematical procedures. The valuation techniques could easily overwhelm a first-time investor or a novice trader as most of the valuation methods are complex. This is where taking financial advice becomes important as a person with sound knowledge of these methods can easily guide a new investor into choosing a stock to invest. Each stock is different and so finding a firm with expert advisors that can help an investor sail through their financial market woos is important.
The following criteria need to be adhered to for becoming a valuer:
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The Indian government has given the authority of valuation under section 247 of the Companies Act, 2013 to the Insolvency and Bankruptcy Board of India (IBBI). This board would handle all procedures associated with valuation.
A valuer is a private or a corporation appointed under the norms of section 247 of the Companies Act, 2013. To be considered an official valuer, an individual or a company must get itself registered as a valuer. Besides, the Companies (Registered Valuers and Valuation) Rules 2017 prescribe the requirements of the valuer.
The following valuations are allowed by the governing authority the valuation rules:
Following educational qualifications are required to enroll as a valuer:
Apart from the above, the individual must have three years of experience in estimating valuation.
Following responsibilities need to be administered by a registered valuer: