What is equity valuation?
Equity valuation is a financial term used to refer to all the techniques, methods and tools implemented to estimate the true value of a company’s equity. It is commonly referred to as the most pivotal aspect of successful investment decision-making.
Typically, the majority of investment banks run a department solely dedicated to equity research. Their analysts carry out equity analysis and compile research reports, overseeing a range of securities across different industries. In simpler terms, equity valuation means a process of determining the fair market value of an equity.
Where have you heard about equity valuation?
If you are interested in either investing or trading, chances are you have heard about equity valuation at least a few times. When making any investment decisions, every participant in the stock market, from small individual investors to fund managers, uses equity valuation to assess all the given options and make further decisions.
What you need to know about equity valuation.
Now, that we’ve got equity valuation definition in place, let’s dig deeper into detail.
The way the entire system behind the stock market works is based on the concept of equity valuation. Modern markets offer a wide diversity of stocks available for trading and investing. The market is continuously receiving a wealth of information and updates on a real-time basis, which, in turn, makes the perceived market value of equities change in the blink of an eye. Markets attempt to assess the financial effect of this information and reflect it in the stock price.
As individual estimates of the effects vary, there might be a difference between the market value of a business and its intrinsic value. Investors usually try to profit by correctly identifying this difference.
Moreover, the true value of any financial asset is usually considered as an indicator of how well that asset will perform in the long term. In equity markets, an asset with a comparatively high intrinsic value is expected to have a higher price in the future, and vice versa – an asset with a comparatively low intrinsic value is expected to fall in price.
In the long run, the true value of a stock, as well as its market price, typically depends on a number of fundamental factors. These can be broadly classified into the following categories:
- Macroeconomic variables;
- The financial health of the business;
- Profits of the business;
- Management of the business.
Therefore, equity valuation can be truly called the basis of the financial system. Mastering the art of equity valuation gives the modern economic system the opportunity to effectively distribute scarce capital resources amongst a multitude of market participants, making it beneficial for the overall stock market ecosystem.