Financial analysts commonly use the comparables valuation method (CVM). It allows investors to value an asset by comparing similar assets recently sold in the market, providing a relative price.
The CVM can be applied to any companies and commodities as long as there are comparable transactions available to compare. The selected comparables must be “similar” enough to effectively apply the method. Some critical factors to consider include industry type, business risk exposure, cash flow generation potential, market share/size etc.
You can use the comparables valuation method with Saxo Hong Kong.
So how does it work?
The CVM is an estimated value that helps investors predict the possible future behaviour of the asset. The formula to calculate it is straightforward:
Asset Value = (Transaction Multiplier x Transaction Price) / Number of Shares Outstanding
- Transaction Multiplier = 𝐹𝑢𝑎𝑥/𝐹𝑒
- Where 𝐹𝑢𝑎𝑥 is the transaction multiple and 𝐹𝑒 is the industry average for similar companies.
- Transaction Price = Transaction Multiplier x Number of Shares Outstanding in a Company or Enterprise Specified under Comparison. When two companies have the same number of outstanding shares, one can use their respective stock price to determine the transaction price.
The trickiest part about using the CVM is determining which transactions are comparable enough to be valid for analysis. It requires thorough research into similar companies that may also be available through strategic partnerships or acquisitions. The whole process is dynamic, and one has to adopt a flexible approach to ensure a robust investment decision.
Once the value of an asset under consideration has been calculated through the comparables valuation method, you can then compare it with the market value of similar assets. If there is a significant difference between the two figures, it may signal that something about this particular asset was not considered when using the CVM. It will prompt further research into those factors to avoid making incorrect decisions based on calculations that may have overlooked some vital information.
Why do traders use CVM in IPO?
The comparables valuation method is commonly used in initial public offerings (IPOs) to determine the fair market value of a company’s stocks. This method helps them decide how much they should pay for their shares to make an acceptable return on investment.
IPOs are priced by determining the intrinsic value of an asset or company through projections of future earnings, growth potential and market opportunities. The CVM is often used to allow investors to price shares without buying them first. It can be advantageous if they wish not to participate in the IPO but still want to find out the total of what they would have made had they invested in it while maintaining flexibility about whether they will purchase IPOs based on their calculations.
The whole process is more speculative than other investments like bonds and commodities. There are more reliable ways of valuing assets based on historical data rather than projections for the future. Allocating funds towards IPOs require some trust in the issuer and an expectation that their plans will come to fruition.
What are the advantages of using CVM?
More flexible approach
The comparables valuation method is recommended when buying shares in an IPO. It can provide a more flexible approach to valuation, enabling investors to make small bets on the value of shares without committing fully or investing large sums of money.
Efficient market analysis and strategy planning
Detecting undervalued/overvalued companies based on CVM helps experts create efficient market analysis and strategy planning processes for companies involved in mergers and acquisitions. It allows them to understand better how their products are doing in the market relative to competitors while also identifying potential merger targets that will be beneficial.
When using this valuation method, it is crucial to keep up with changes in the market and understand how the company has performed over time to identify any potential pitfalls. One can plan around those issues and create strategies to help the business provide products and services that better suit their customers’ needs.
Ensure robust investment decisions
Using the comparables valuation method ensures robust investment decisions by comparing prices of similar assets. It also avoids errors caused by incorrect assumptions about revenue growth, capital expenditures or working capital requirements, leading to lousy decision-making processes.