UBS EGQ Regression Valuation
26.1 INTRINSIC MEETS RELATIVE VALUATION
Using EGQ as the independent variable in a valuation regression is based on our thesis that differences in observed valuation multiples of companies similar in systematic risk are mostly driven by differences in the market's expectation for each company's value-added growth potential. We define value-added growth as incremental economic profits. Incremental economic profits are future increases in economic profit beyond the level currently earned.
Estimating incremental economic profits requires forward-looking analysis of a company's potential to grow its business and, importantly, the investments required to support that growth. We think the best framework for quantifying and testing such forecasts is a hybrid DCF and future economic profit model, such as the UBS Value Creation Analysis Model (VCAM).
DCF-based valuation produces “intrinsic” values, and a DCF estimated intrinsic value will be either higher or lower than the observed market value. While this stand-alone valuation is important, such an approach can suffer when all companies examined are screening as intrinsically attractive or unattractive. The benefit of using an EGQ regression is that it identifies which companies are the most attractive and the most unattractive using DCF analysis and intrinsic values as the basis of comparison. Using an observed valuation multiple as the dependent variable, and EGQ as the independent variable, companies ...