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Equity Valuation: Models from Leading Investment Banks by Armin Varmaz, Thorsten Poddig, Jan Viebig

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22

Introducing “EGQ” – Where Intrinsic Methods and Empirical Techniques Meet

The Global Valuation & Accounting Group at UBS Investment Research has developed a system to faithfully combine DCF-based intrinsic valuation methodologies with important relative valuation considerations using linear regressions. The key to this next level in valuation is a metric that the group at UBS calls the Economic Growth Quotient (EGQ).

EGQ is a measure of a company's value-added growth potential. Quantifying value added growth potential is an analytical challenge that the group believes is best approached by focusing on a company's ability to generate incremental economic profits. The group believes that the most significant determinant of a company's observed valuation relative to its peers, or other companies of similar systematic risk, is the market's outlook for the company's ability to generate incremental economic profits over both the near and distant future. The empirical evidence presented later in their valuation regressions using EGQ as the independent variable support this concept.

Incremental economic profit projections require operating performance forecasts based upon rigorous fundamental analysis of the company and its industry – operating forecasts that capture both the growth potential of a business and the investments required to support that growth. The valuation experts at UBS believe that the best framework for making such forecasts is a discounted cash flow model with economic ...

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