multipleoftencomesfromwhatthemarketispaying
forsimilarfirms.Itcanbearguedthatthebruntofthe
responsibility in a relative valuation is borne by
financial markets. In a sense, we are challenging
investors who have a problem with a relative
valuationtotakeitupwiththemarketiftheydislike
the value.- Marketimperatives.Relativevaluationismuchmore
likelytoreflectthecurrentmoodofthemarket,since
itattemptstomeasurerelativeandnotintrinsicvalue.
Thus,inamarketwhereallInternetstocksseetheir
prices bid up, relative valuation is likely to yield
highervaluesfor thesestocksthandiscountedcash
flow valuations. In fact, by definition, relative
valuationswillgenerallyyieldvaluesthatarecloser
to market prices than discounted cash flow
valuations, across all stocks. This is particularly
importantforthoseinvestorswhosejobitistomake
judgmentsonrelativevalueandwhoarethemselves
judged on a relative basis. Consider, for instance,
managers of technology mutual funds. These
managerswillbejudgedbasedonhowtheirfundsdo
relative to other technology funds. Consequently,
theywillberewardediftheypicktechnologystocks
that are undervalued relative to other technology
stocks, even if the entire sector is overvalued.
Thestrengths ofrelativevaluationarealso its weaknesses.
First, the easewith which a relative valuationcan be put
together, pulling together a multiple and a group of
comparablefirms,canalsoresultininconsistentestimatesof
valuewherekeyvariablessuchasrisk,growth,orcashflow
potentialareignored.Second,thefactthatmultiplesreflect