multipleusedinthesector.Infact,whenthemultipleinuse
conventionally does not reflect fundamentals, which can
happenifthesectorisintransitionorevolving,wewillget
misleading estimates of value.
Should I Use Market or Sector Valuation?
Inmostrelativevaluations,wevalueafirmrelativetoother
firmsintheindustryinwhichthefirmoperatesandattemptto
answer a simple question: Given how other firms in the
industry(sector)arepricedbythemarket,isthisfirmunder-
or overvalued? Within this approach, we can define
comparable firms narrowly as being firms that not only
operateinthesamebusinessasthefirmbutalsolooklikethe
firmintermsofsizeormarketserved,orbroadly,inwhich
case we will have far more comparable firms. If we are
attemptingtocontrolfordifferencesacrossfirmssubjectively,
weshouldstickwiththenarrowergroup.If,though,weplan
tocontrolfordifferencesstatistically—witharegression,for
instance—we should go with the broader definition.
In the chapters on relative valuation in Part Two, we
presentedanalternativeapproachtorelativevaluation,where
wevaluedfirmsrelativeto theentire market.Whenwedo
this, we are not only using a much larger universe of
questions,butasking adifferentquestion:Givenhowother
firms in the market are priced, is this firm under- or
overvalued?Afirmcanbeundervaluedrelativetoitssector
butovervalued relativeto themarket (orviceversa), ifthe
entire sector is mispriced.
Theapproachyouuseforrelativevaluationwilldependagain
on what your task is defined to be. If you want to stay