What are the main equity valuation methods used by professional investors?

Professional investors use multiple equity valuation methods in parallel. Discounted cash flow analysis estimates intrinsic value based on projected future cash flows. Comparable company analysis values a stock relative to peer group multiples. Precedent transaction analysis uses M&A deal multiples as benchmarks. Sum-of-parts analysis is used for diversified businesses where different divisions have different value drivers.

What is an equity valuation example for a simple company?

A simple equity valuation example involves estimating a company's annual free cash flow, projecting growth over a forecast period, applying a terminal growth rate, and discounting back to present value using a risk-adjusted discount rate. The result is compared to the current market capitalisation to assess whether the stock is overvalued, fairly valued, or undervalued relative to the DCF-implied intrinsic value.

What is discounted cash flow analysis and when is it most useful for equity valuation?

Discounted cash flow analysis values a company by projecting future free cash flows and discounting them back to present value using a rate that reflects the risk of those cash flows. It is most useful when a company has stable, predictable cash flows and when the analyst has reasonable confidence in multi-year projections. DCF is less reliable for early-stage companies, highly cyclical businesses, or companies undergoing significant business model transitions.

How do relative valuation multiples work and what are their limitations?

Equity valuation methods vary significantly by sector. Banks are typically valued on price-to-book and return on equity. REITs are valued on funds from operations and cap rates. Biotech pre-revenue companies are valued on risk-adjusted NPV of pipeline assets. High-growth technology companies are valued on EV/revenue multiples. Using the wrong valuation methodology for a given sector produces misleading conclusions.