14.3 Equity Valuation
We look at Equity Valuation from different perspectives.
- Going-Concern value sees the firm from a perpetual operating perspective. It is an ongoing concern that will produce EBIT (or EBITDA) forever.
- Liquidation Value is diametrically opposed to the going concern value. Here we imagine what the firm’s assets would fetch were the firm to go out of business and its assets liquidated, i.e., sold off to the highest bidders or available buyers.
- Book Value (BV) represents the accountant’s stated net (common) equity divided by the number of shares outstanding (NOSO).
- Relative Value compares a security to another based on some shared or relative metric, such as default risk.
- Market Value (P for Price per Share) is defined as the market value of the firm’s equity. Markets can misprice assets on occasion.
- Intrinsic Value (V) represents the “intrinsic” or “internal” worth of the company based on financial analytic formulae and models. You may think of this as what the shares are “really” worth. Such formulae often rely on a discounted cash flow paradigm, e.g., the DDM. The intrinsic value may differ from the market price, thereby offering investors the opportunity to purchase shares cheaply or sell the shares short, if over-valued. Does V = P? If not, what advantage does the investor have?
All the foregoing valuations may differ from one another. In a perfectly efficient market, observed market prices should equal intrinsic values.
Equity Valuation and the Macroeconomy
How we value the stock market now and in the future influences major economic and social policy decisions that affect not only investors, but society at large, even the world. If we exaggerate the present and future value of the stock market, then as a society we may invest too much in business start-ups and expansions, and too little in infrastructure, education, and other forms of human capital. If we think the market is worth more than it really is, we may become complacent in funding our pension plans, in maintaining our savings rate, in legislating an improved Social Security system, and in providing other forms of social insurance. We might also lose the opportunity to use our expanding financial technology to devise new solutions to the genuine risks – to our homes, cities, and livelihoods – that we face.
-Irrational Exuberance by Robert J. Shiller
Preface, p. xii
(Princeton University Press, 2000)