• Global Frameworks: CFA Level 2 (Equity Valuation).

1. Absolute Valuation: Dividend Discount Models (DDM)
Absolute valuation determines the intrinsic value of a stock by discounting its projected future cash flows back to the present.
  • Gordon Growth Model (Constant Growth): Assumes dividends grow at a stable rate (g) indefinitely:

    P_0 = D_1 / (r − g)
    • Required Assumptions: The required rate of return (r) must be strictly greater than the long-term dividend growth rate (g), and the growth rate must remain constant forever.

  • Multistage Dividend Discount Model: Used for high-growth firms that experience an initial period of supernormal growth before settling into a mature, stable growth rate:

    P_0 = Σ_{t=1..n} (D_t / (1 + r)^t) + P_n / (1 + r)^n

    where P_n = D_{n+1} / (r − g_stable)

2. Free Cash Flow Valuation Models
For companies that do not pay dividends, analysts evaluate cash flows using Free Cash Flow models:
  • Free Cash Flow to Firm (FCFF): The cash available to all capital providers (both debt and equity holders) after meeting all operating expenses and capital expenditure needs:

    FCFF = EBIT(1 − t) + Depreciation − Capital Expenditures − Δ Working Capital

    Firm Value = Σ_{t=1..∞} (FCFF_t / (1 + WACC)^t)


  • Free Cash Flow to Equity (FCFE): The cash remaining for common shareholders after the company has met all operating expenses, capital investment needs, and net debt obligations:

    FCFE = FCFF − Interest Expense(1 − t) + Net Borrowing

    Equity Value = Σ_{t=1..∞} (FCFE_t / (1 + r_e)^t)

3. Relative Valuation: Multiple Matrix
Relative valuation estimates an asset’s worth by comparing its financial metrics to those of similar, publicly traded peer companies.
                    ┌─────────────── Valuation Multiples ────────────────┐
                    ▼                                                    ▼
         [Equity Multiples]                                    [Enterprise Multiples]
      P/E (Price-to-Earnings);                              EV/EBITDA; Clears out capital
      Impacted by capital structure.                         structure differences.

  • Price-to-Earnings (P/E): Calculated as Market Price per Share divided by Earnings Per Share. It is highly sensitive to a firm’s capital structure choices.
  • Enterprise Value to EBITDA (EV/EBITDA): EV measures the total value of the operating business (Market Equity + Total Debt – Cash). Dividing EV by EBITDA provides a metric that is independent of the firm’s capital structure and tax environment, making it ideal for international cross-border comparisons.

 
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