Equity Valuation and Portfolio Management

BASIC PRINCIPLES OF RELATIVE VALUATION

Analysis based on relative valuation requires the analyst to choose a suitable universe of companies that are more or less comparable with each other. There is no standardized approach concerning how to choose such a universe of similar firms, and the process relies to some extent on an analyst's personal judgment concerning the particular industry and geography involved. However, it is possible to lay out some general principles that combine practitioners' insights with the results of academic inquiry.

Sources of Data

Relative valuation approaches can only be employed if there is sufficient information, produced on an approximately consistent footing, about the various companies that are the subjects of analysis. In most countries, companies that are publicly listed on stock exchanges are required by law and regulation to report their historical results publicly in a timely manner, or risk being delisted from the exchange. (There may be occasional exceptions to this general pattern, particularly for entities that are majority owned or controlled by their home country government. But such anomalies are not frequently observed except during crisis periods.) Consequently, it is almost always possible to obtain information about listed companies' historical results. However, multiples based solely on historical data may not provide a complete picture, as most analysts would probably agree that forward-looking estimates are likely to provide more ...