Everything you need to know about Equity Valuation!

Valuation is at the heart of financial decision-making, whether you're investing in a company, acquiring one, or simply assessing performance. We will be starting this 10-part series in which we break down valuation concepts in a clear, structured manner, moving from foundational principles to advanced applications. Whether you're a student or investor, each article builds on the last to give you a practical and complete understanding of how businesses are valued in the real world.

What is valuation and why is it important?

Understanding an asset's value and the factors influencing it is essential for intelligent decision-making whether selecting portfolio investments, mergers, acquisitions or spinoffs. Here we’ll be specifically talking about equity valuation for investing. While valuation methods vary across asset types and some are easier to value than others, the underlying principles remain consistent for both financial and real assets. Despite differences in complexity and uncertainty, most assets can be reasonably valued using these core principles.

For example, when Facebook acquired Instagram for USD 1 billion in 2012, many questioned the deal’s value, as Instagram had little revenue. However, Facebook’s valuation considered user growth, strategic synergies, and long-term potential illustrating how valuation often looks beyond current financials.

Different methods of equity valuation

Valuation methods can be broadly categorized into three key approaches:

Intrinsic valuation, which is the most widely used, typically represented by the Discounted Cash Flow (DCF) method, estimates an asset’s value based on its expected future cash flows, adjusted for time and risk. Intrinsic valuation can almost be used for every asset but is best used for established, cash-generating companies with predictable future cash flows, such as Large-Cap firms, utilities, and tech companies with steady earnings. This is the only valuation method where one can incorporate its own judgements into the valuation.

Relative valuation involves comparing a company’s value to its peers using multiples like P/E or EV/EBITDA, assuming similar businesses should trade at similar valuations. This is ideal for high-growth companies, startups, or sectors with many peers. Works well when market comparables are available, like in consumer goods, retail or IT services.

Asset-based valuation determines a firm’s worth by assessing the value of its assets minus liabilities, often used for asset-heavy or underperforming businesses. Each method offers unique insights and is chosen based on context, data, and the valuation objective. This method is suitable for asset-heavy businesses or those facing liquidation, like real estate firms, holding companies, manufacturing, or distressed companies with tangible assets on their balance sheets.

Additionally, choosing the right equity valuation method ensures accurate assessment of a company’s worth, aligned with its business model, industry, and financial profile. It helps investors and analysts make informed decisions, avoiding mispricing risks and ensuring relevance based on cash flow stability, asset intensity, or market comparability.

What’s Next?

Having understood what valuation is, its importance and its different types, in the upcoming articles we will delve deeper into the three core valuation approaches. These form the foundation of most valuation techniques and choice among them depends on the business type, the availability of data, and the specific purpose of the valuation, all of which we’ll explore in detail going forward.