What Is Relative Value?

Relative value is a method of determining an asset's worth that takes into account the value of similar assets. This is in contrast with absolute value, which looks only at an asset's 澳洲幸运5官方开奖结果体彩网:intrinsic value and does not compare it to other assets. The 澳洲幸运5官方开奖结果体彩网:price-to-earnings ratio (P/E ratio) is a popular valuation method that can be u❀🎐sed to measure the relative value of stocks.

Understanding Relative Value

Value investors examine the 澳洲幸运5官方开奖结果体彩网:financial statements of competing companies before deciding where to invest their money. They look at relevant footnotes, management commentary, and economic data to assess the stock😼's value relative to its peers.

Steps in relative valuation may include:

• First, identifying comparable assets and corporations. In these cases, it can be useful to view 澳洲幸运5官方开奖结果体彩网:market capitalizations and revenue or sales figures. Their stock prices represent how the market values comparable companies at any given time.
• Deriving price multiples from these initial figures. Price multiples can include ratios, such as the P/E ratio or the 澳洲幸运5官方开奖结果体彩网:price-to-sales ratio (P/S ratio).
• Comparing these multiples across a company’s peer or competitor group to determine if the company's stock is undervalued relative to other firms.

Benefits of Relative Valuation

Investors must always choose among the investments that are actually available at any given time, and relative valuation helps them to do that. By 2019, it was easy to look back at the prices of most U.S. stocks in 2009 and realize that they were undervalued. However, that does not help one to choose better investments today. That is where a relative valuation method like the 澳💫洲幸运5官方开奖结果体彩网:stock market capitalization-to-GDP ratio shines. The 澳洲幸运5官方开奖结果体彩网:World Bank maintains data on stock market capitalization as a percentage of GDP for many nations covering several decades. With U.S. stocks near record highs in terms of stock market capitalization as a p💛ercentage of GDP in 2019ꦜ, stocks in most other countries were relatively inexpensive.

Criticism of Relative Valuation

The primary flaw of relative valuation is that it may condemn investors to making the best of a bad situation. When limited to a single asset class, relative valuation can do little more than reduce losses in extreme circumstances. For example, 澳洲幸运5官方开奖结果体彩网:value funds generally did much better than the S&P 500 during the 2000-2002 澳洲幸运5官方开奖结果体彩网:bear market. Unfortunately, most of them still lost money.

Relative Valuation vs. Intrinsic Valuation

Relative valuation is one of two important methods of placing a monetary value on a company; the other is intrinsic valuation. Investors might be familiar with the 澳洲幸运5官方开奖结果体彩网:Discounted Cash Flows (DCF) method for determining the intrinsic value of a company. While relative valuation incorporates many multiples, a DCF model uses a company’s future free cash flow projections and discounts them. That is achieved by using a required annual rate. Eventually, an analyst will arrive at a 🎶present value estimate, which can then be used to evaluate the potential for investment. If the DCF value is higher than the cost of the investment, the opportunity may be a good one.

An Example of Relative Value

Consider the following table of fi🌃nancial information com♏paring Microsoft to other technology firms.

Based on the above relative value analysis results, Microsoft is 🎉overvalued relative to Oracle. However, Microsoft is also undervalued relative to VMware.