A valuation is a process that helps determine a company price. There are two ways how can we determine the value of company: a) absolute valuation or b) relative valuation.
In reality it is hard to set correct price for a company as its cost is influenced by many factors.
Common metrics we can use in relative valuation are:
This chart provides you with a comparison between absolute and relative valuation.
The main advantage for absolute valuation is that the final result is more precise as it is based on actual numbers of the given company rather than feelings. On the other hand relative valuation is far more simple, key features are price to earnings or dividend payout comparison of one company to the another. Yet absolute valuation has drawbacks in its complexity and it can also be easily misinterpreted with the work of skilled accountant that can mislead company free cash flow. Relative valuation has negative sides in the fact that it can be hard to find two firms to compare as no company is same. Furthermore, when you are comparing one company to another, you are assuming that the comparative company is fairly valued, but that may be false.
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