Glossary
Valuation
The process of estimating what a company or security is worth, using cash-flow models, comparisons with similar companies or the value of its assets.
On this page
Valuation is the work of estimating what an asset is worth, and by extension the word for the level at which the market currently prices it ("the valuation looks stretched"). For a stock, it means judging whether the share price is reasonable relative to the cash the business is likely to produce. It matters because a great company bought at too high a price can still be a poor investment.
The main approaches
- Intrinsic (cash-flow) valuation. A discounted cash flow model projects future free cash flows and discounts them back to today at a rate that reflects risk.
- Relative valuation. Compare price multiples, such as the P/E ratio, EV/EBITDA or price-to-sales, with similar companies or with the stock's own history.
- Asset-based valuation. Add up what the assets would fetch, less liabilities. Useful for banks, holding companies and businesses being wound down.
What to keep in mind
Every valuation is a set of assumptions about growth, margins and risk; small changes in the discount rate or long-term growth rate can swing a cash-flow estimate by 30% or more. Multiples hide those assumptions rather than avoiding them, and a whole sector can be expensive at once. Good practice is to use more than one method, test a range of inputs, and ask what the current price implies the company must achieve.