Investment Valuation: Definition and Types

Investment valuation refers to the process of determining the fair value of an asset or a company using quantitative calculations. There are several ways of determining the worth of a project; and each valuation method is affected by the company’s financial performance and economic events in the external environment. Investment valuation can also be described as the analytical process of establishing the actual and projected worth of an asset or company. When valuing a company, the valuer examines the firm’s shares, market value, cash flows, future earnings, etc.

There are two major classifications of investment valuation models are:

  • Relative Model: in this model, an investment’s worth is measured in comparison with other investment projects based on their market prices.
  • The Absolute Model: This model requires the company to find the fair value of an asset based on their projected returns or cash flows without comparing with other projects.

Investment valuation models are also divided into three types:

  • Dividend Discount Model (DDM): the dividend discount model is one of the absolute models of investment valuation. It is used to evaluate the value of an investment using dividends paid to shareholders. Based on this model, a company is valuable if it provides consistent stock dividends for shareholders, meaning that the firm is profitable and capable of creating stakeholder value.
  • Discount Cash Flow Method (DCF): The cash flow dividend method is appropriate when a company does not pay dividends consistently. Shareholders will evaluate their investments in the company based on their discounted future cash flows. Based on this model, a viable project is the one that provides consistent, positive and predictable cash flows.
  • Comparable Method (CM): The comparable method is a relative valuation method that compares the company’s price with industry benchmarks. In this case, the share price of a company is compared to the industry average to determine its performance when compared to other companies in the industry.
  • Asset-Based Valuation: The asset-based valuation of a firm involves the valuation of a company’s assets to determine the fair market value of the firm’s total assets, less liabilities. This investment valuation of a company evaluates the assets of the company to determine its fair market value.

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