Equity Valuation: Models from Leading Investment Banks

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Overview of Valuation

Analysts use a wide spectrum of models, ranging from the simple to the sophisticated. These models often make very different assumptions about the fundamentals that determine value, but they do share some common characteristics and can be classified in broader terms. There are several advantages to such a classification – it makes it is easier to understand where individual models fit into the big picture, why they provide different results and when they have fundamental errors in logic.

In general terms, there are four approaches to valuation. The first, discounted cash flow valuation, relates the value of an asset to the present value of expected future cash flows on that asset. The second, liquidation and accounting valuation, is built around valuing the existing assets of a firm, with accounting estimates of value or book value often used as a starting point. The third, relative valuation, estimates the value of an asset by looking at the pricing of “comparable” assets relative to a common variable like earnings, cash flows, book value or sales. The final approach, contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics. This is what generally falls under the rubric of real options.

Within each of these approaches lie a myriad of sub-approaches, sharing common themes while varying on the details. Discounted cash flow valuation models can take three forms – cash flow models, where aggregate ...