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

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Closing Thoughts on Value Enhancement

Value enhancement can take varied forms, depending in large part on how we approach valuation. With discounted cash flow valuation, the emphasis is on the fundamentals that drive value – cash flows, growth and risk. For an action to create value, it has to affect one or more of these levers of value. Accounting-based valuation models are focused on accounting earnings and book value. Not surprisingly, value enhancement is tailored to changing one or both of these measures, with tenuous connections to intrinsic value. With relative valuation, the focus shifts to multiples and how the market is pricing the peer group or sector. Consequently, value enhancement is much more tailored to market moods and perceptions, even if such perceptions may be unrelated to fundamentals. Real option valuations are not alternatives but supplements to conventional valuation models and consider the value added by increased flexibility and access to opportunities. Value enhancement in this framework has a heavy strategic component with the benefits often unlikely to show up in conventional valuation models.

So which value enhancement approach should you pick? The answer depends upon a number of factors. If you believe that markets are efficient, your choices become easier since relative and discounted cash flow approaches converge. If markets are not efficient, you have a fundamental decision to make on whether you want to emphasize price enhancement or value ...

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