Equity Markets, Valuation, and Analysis

CHAPTER 7Fundamentals of Equity Valuation

Emmanuel Boutron

Associate Professor of Finance, University Paris Nanterre

Alain Coën

Professor of Finance, Université du Québec à Montréal

Didier Folus

Professor of Finance, University Paris Nanterre

INTRODUCTION

Equity valuation is a central topic in finance because it lies at the cornerstone of the relationships among a firm's stakeholders, including investors, lenders, and employees. Since seminal studies in the early 1930s, equity valuation methods stand among the main topics in the finance literature. These methods highlight the importance of both the value of time and price risk in the investment process, often using the discounting of expected future cash flows. This context calls for defining a required rate of return or hurdle rate. Valuing equity is critical in finance because any corporate decision related to investment, financing, or dividend policy should be made according to the value-maximizing principle. Thus, valuation methods help managers in decision-making. The different approaches developed by academics and practitioners can be divided into three main categories: (1) asset-based valuation, (2) market-based valuation, and (3) other valuation approaches. This chapter's primary goal is to present the fundamentals of equity valuation.

This chapter is organized as follows. The next section defines equity valuation and highlights its crucial role in modern finance for academics and practitioners. The following three ...