What Is Absolute Value?

Absolute value, also known as an intrinsic value, refers to a business valuation method that uses 澳洲幸运5开奖号码历史查询:discounted cash flow (DCF) analysis to determine a company's financial worth. The absolute value method diffe♓rs 🌠from the relative value models that examine what a company is worth compared to its competitors. Absolute value models try to determine a company's intrinsic worth based on its projected cash flows.

Understanding Absolute Values

Finding out whether a stock is under or overvalued is a primary play of 澳洲幸运5开奖号码历史查询:value investors. Value investors use popular metrics like the 澳洲幸运5开奖号码历史查询:price-to-earnings ratio (P/E) and the 澳洲幸运5开奖号码历史查询:price-to-book ratio (P/B) to determine whether to buy or sell a stock based on its estimated worth. In addition to using these ratios a൲s a valuation guide, another way to determine absolute value is the discounted cash flow🍸 (DCF) valuation analysis.

Some form of a company’s future 澳洲幸运5开奖号码历史查询:cash flows (CF) is estimated with a DCF model and is then discounted to the 澳洲幸运5开奖号码历史查询:present value in order to determine an absolute value for the company. The present value is regarded as the true worth or intrinsic value of the firm. By compa🍸ring what a company's share price should be given its absolute value to the price that the stock is actually trading at, investors can determine if a stock is currently under or overvalued.

Examples🍬 of methods used under the DCF model include the following models:

• 澳洲幸运5开奖号码历史查询:Dividend discount model
• 澳洲幸运5开奖号码历史查询:Discounted asset model
• 澳洲幸运5开奖号码历史查询:Discounted residual income method
• 澳洲幸运5开奖号码历史查询:Discounted FCF method

All of these models require a rate of return or discount rate which is used to discount a firm’s cash flows—dividends, earnings, 澳洲幸运5开奖号码历史查询:operating cash flow (OCF), or free cash flow (FCF)—to get the absolute value of the firm. Depending on the method employed to run a valuation analysis, the investor or analyst could use either the cost of equity or the 澳洲幸运5开奖号码历史查询:weighted average cost of capital (WACC) as a discount rate.

Absolute Value vs. Relative Value

Relative value is the opposite of absolute value. While absolute value examines the intrinsic value of an asset or company without comparing it to any others, relative value is based on the value of similar assets or companies. Analysts and investors who use relative value analysis for stocks look at 澳洲幸运5开奖号码历史查询:financial statements and other multiples of the companies they're interested in and compare it to other, similar firms to determine if those potenti🃏al companies are over or undervalued. For instance, an investor will look at the variables—market capitalization, revenues, sales figures, P/E ratios, etc.—for companies like Amazon, Target, and/or Costco if they want to know the relative value of Walmart.

Challenges of Using Absolute Value

Estimating a company’s absolute value does not come without its setbacks. Forecasting the cash flows with complete certainty and projecting how long the cash flows will remain on a growth trajectory is challenging. In addition to predicting an accurate 澳洲幸运5开奖号码历史查询:growth rate𒅌, evaluating an appropriate discount rate to calculate 𒆙the present value can be difficult.

Since the absolute valuation approach to determining the worth of a stock is strictly based on the characteristics and fundamentals of the company under analysis, there is no comparison made to other companies in the same sector or industry. But companies within the same sector should be considered when analyzing a firm since a market-moving activity—a bankruptcy, government regulatory changes, disruptive innovation, employee layoffs, 澳洲幸运5开奖号码历史查询:mergers and acquisitions, etc.—in any one of these compa♑nies can affect how the entire sector moves. Therefore, the best way to evaluate a stock’s real value is to incorporate a mix of both the absolutꦫe and relative value methods.

Example of Absolute Value

Consider Company X, which currently trades on the market for $370.50. After running a DCF analysis on its estimated future cash flows, an analyst determines that the absolute va🦄lue of the firm is $450.30. This presents a buying opportunity for an investor who is led to believe, based on the numbers, that Company Xꦜ is undervalued.