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What Is Equity Valuation?

Jim B.
Jim B.

Equity valuation is a process used by investors to attempt to determine the value of stocks, or equities. By determining the value of a company, both in the present and projected into the future, and comparing its value to its market price, an investor can decide whether or not the company represents a worthy investment. Many investors practice quantitative equity valuation, which means that they use different financial measurements and ratios as a way to come up with a stock's value. Other investors prefer a more subjective form of valuation, measuring intangible assets, like company leadership or marketing strategies, which might set a company apart from its competitors.

When an investor buys stock in a company, he is essentially gaining a minority ownership in the company, which is also known as equity. For that reason, investors wish to know about the financial prospects of their target companies, and equity valuation is one way to gauge these prospects. Valuation allows individuals to take some of the guesswork out of investing, although it cannot remove all of the risks.

Woman with hand on her hip
Woman with hand on her hip

If executed properly, equity valuation can determine the intrinsic value of a specific company. The intrinsic value is the true measurement of the value of a company, regardless of how it is judged by the market. In fact, if the intrinsic value of a company is significantly higher than the company's current market price, the company is probably a solid investment. But measuring intrinsic value is an inexact science, with methods often varying from investor to investor.

Some investors prefer to perform their equity valuation by the numbers. These investors are likely to study income reports and balance sheets of companies to gather important financial information about cash flow, income, debt, and so on. Ratios can be created from these statistics which will shed light on a company, especially when these ratios are compared to other companies within the same industry. Ideally, an investor can project a company's financial prospects into the future with these numbers, thus identifying its potential.

For some investors, the numbers fall short when it comes to equity valuation. Such investors are more likely to rely on those aspects of a company that can't be measured statistically. As an example, a company might be suffering through difficult financial times, but the hiring of a new CEO with an outstanding track record could signal improved fortunes in the future. In some cases, investors can use a combination of both quantitative and qualitative techniques to make a complete assessment of their equity options.

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