narrowly focused on your sector and make judgments on
whichstocksareunder-orovervalued,youshouldstickwith
sector-basedrelativevaluation.Ifyouhavemoreleewayand
are trying to find under- or overvalued stocks across the
market,youshouldlookatthesecondapproach—perhapsin
addition to the first one.
Can a Firm Be Undervalued and Overvalued atthe Same
Time?
If we value a firm using both discounted cash flow and
relative valuation models, we mayvery wellget different
answersusingthetwo—thefirmmaybe undervaluedusing
relative valuation models but overvalued using discounted
cashflowmodels.Whatdowemakeofthesedifferences,and
whydotheyoccur?Ifafirmisovervaluedusingadiscounted
cashflowmodelandundervaluedusingrelativevaluation,it
couldbeanindicationthatthesectorisovervaluedrelativeto
its fundamentals. For instance, in March 2000, we valued
Amazonat$30ashareusingadiscountedcashflowmodel
whenitwastradingat$70ashare—itwasclearlyovervalued.
Atthesametime,acomparisonofAmazontootherdot-com
firms suggested that it was undervalued relative to these
firms.
Ifafirmisundervaluedusingadiscountedcashflowmodel
andovervaluedusingrelativevaluation,itmayindicatethat
thesectorisundervalued.ByMarch2001,Amazon’sstock
price had dropped to $15but thevalues of otherInternet
stockshaddroppedbyalmost 90 percent.InMarch2001,a
discountedcashflowvaluationsuggestedthatAmazonwas
undervalued,butarelativevaluationindicatedthatitwasnow
overvalued relative to the sector.