cardsand 1965 FordMustangsoutthereandthatthepricesat
whichtheyhavebeenboughtandsoldcanbeobtained.With
equity valuation, relative valuation becomes more
complicated by two realities. The first is the absence of
similar assets, requiring us to stretch the definition of
comparabletoincludecompaniesthataredifferentfromthe
onethatwearevaluing.Afterall,whatcompanyintheworld
is remotely similar to Microsoft or General Electric? The
otheristhatdifferentwaysofstandardizingprices(different
multiples) can yield different values for the same company.
Inourearlierdiscussion ofDCFvaluation,we arguedthat
DCFvaluationwasasearch(albeitunfulfilled)forintrinsic
value.Inrelativevaluation,wehavegivenuponestimating
intrinsicvalueandessentiallyputourtrustinmarketsgetting
it right, at least on average.
Variations on Relative Valuation
Inrelativevaluation,thevalueofanassetisbasedonhow
similarassetsarepriced.Inpractice,therearethreevariations
onrelativevaluation,withthedifferencesprimarilyinhow
wedefinecomparablefirmsandcontrolfordifferencesacross
firms:
1.Directcomparison. Inthisapproach,analyststry tofind
one or two companies that look almost exactly like the
companytheyaretryingtovalueandestimatethevaluebased
onhowthesesimilarcompaniesarepriced.Thekeypartin
this analysis is identifying these similar companies and
getting their market values.