Introduction to Evaluation:
Evaluation is a systematic process of assessing the merit, worth, and value of a program,
project, policy, or intervention. It involves gathering, analyzing, and interpreting data to
determine the extent to which objectives are achieved, impacts are realized, and lessons are
learned. Evaluation serves various purposes, including accountability, learning, decision-
making, and improvement.
Valuation is the analytical process of determining the current (or projected) worth of an asset or
a company. There are many techniques used for doing a valuation. An analyst placing a value
on a company looks at the business's management, the composition of its capital structure, the
prospect of future earnings, and the market value of its assets, among other metrics.
Key take aways
Valuation is a quantitative process of determining the fair value of an asset, investment, or firm.
In general, a company can be valued on its own on an absolute basis, or else on a relative basis
compared to other similar companies or assets.
There are several methods and techniques for arriving at a valuation—each of which may
produce a different value.
Valuations can be quickly impacted by corporate earnings or economic events that force
analysts to retool their valuation models.
While quantitative in nature, valuation often involves some degree of subjective input or
assumptions.
Valuation
Investopedia / Mira Norian
Understanding Valuation
A valuation can be useful when trying to determine the fair value of a security, which is
determined by what a buyer is willing to pay a seller, assuming both parties enter the
transaction willingly. When a security trades on an exchange, buyers and sellers determine the
market value of a stock or bond.
The concept of intrinsic value, however, refers to the perceived value of a security based on
future earnings or some other company attribute unrelated to the market price of a security.
That's where valuation comes into play. Analysts do a valuation to determine whether a
company or asset is overvalued or undervalued by the market.
Types of Valuation Models
Absolute valuation models attempt to find the intrinsic or "true" value of an investment based
only on fundamentals. Looking at fundamentals simply means you would only focus on such
things as dividends, cash flow, and the growth rate for a single company, and not worry about
any other companies. Valuation models that fall into this category include the dividend discount
model, discounted cash flow model, residual income model, and asset-based model
.
Relative valuation models, in contrast, operate by comparing the company in question to other
similar companies. These methods involve calculating multiples and ratios, such as the price-to-
earnings multiple, and comparing them to the multiples of similar companies.
For example, if the P/E of a company is lower than the P/E multiple of a comparable company,
the original company might be considered undervalued. Typically, the relative valuation model is
a lot easier and quicker to calculate than the absolute valuation model, which is why many
investors and analysts begin their analysis with this model.
Types of Valuation Methods
There are various ways to do a valuation.
Comparables Method
The comparable company analysis is a method that looks at similar companies, in size and
industry, and how they trade to determine a fair value for a company or asset. The past
transaction method looks at past transactions of similar companies to determine an appropriate
value. There's also the asset-based valuation method, which adds up all the company's asset
values, assuming they were sold at fair market value, to get the intrinsic value.
In investments, a comparables approach is often synonymous with relative valuation.
Sometimes doing all of these and then weighing each is appropriate to calculate intrinsic value.
Meanwhile, some methods are more appropriate for certain industries and not others. For
example, you wouldn't use an asset-based valuation approach to valuing a consulting company
that has few assets; instead, an earnings-based approach like the DCF would be more
appropriate.
Discounted Cash Flow Method
Analysts also place a value on an asset or investment using the cash inflows and outflows
generated by the asset, called a discounted cash flow (DCF) analysis. These cash flows are
discounted into a current value using a discount rate, which is an assumption about interest
rates or a minimum rate of return assumed by the investor.
DCF approaches to valuation are used in pricing stocks, such as with dividend discount models
like the Gordon growth model.
If a company is buying a piece of machinery, the firm analyzes the cash outflow for the
purchase and the additional cash inflows generated by the new asset. All the cash flows are
discounted to a present value, and the business determines the net present value (NPV). If the
NPV is a positive number, the company should make the investment and buy the asset.
Precedent Transactions Method
The precedent transaction method compares the company being valued to other similar
companies that have recently been sold. The comparison works best if the companies are in the
same industry. The precedent transaction method is often employed in mergers and acquisition
transactions.
How Earnings Affect Valuation
The earnings per share (EPS) formula is stated as earnings available to common shareholders
divided by the number of common stock shares outstanding. EPS is an indicator of company
profit because the more earnings a company can generate per share, the more valuable each
share is to investors.
Analysts also use the price-to-earnings (P/E) ratio for stock valuation, which is calculated as the
market price per share divided by EPS. The P/E ratio calculates how expensive a stock price is
relative to the earnings produced per share.
For example, if the P/E ratio of a stock is 20 times earnings, an analyst compares that P/E ratio
with other companies in the same industry and with the ratio for the broader market. In equity
analysis, using ratios like the P/E to value a company is called a multiples-based, or multiples
approach, valuation. Other multiples, such as EV/EBITDA, are compared with similar
companies and historical multiples to calculate intrinsic value.
Limitations of Valuation
When deciding which valuation method to use to value a stock for the first time, it's easy to
become overwhelmed by the number of valuation techniques available to investors. There are
valuation methods that are fairly straightforward while others are more involved and
complicated.
Unfortunately, there's no one method that's best suited for every situation. Each stock is
different, and each industry or sector has unique characteristics that may require multiple
valuation methods. At the same time, different valuation methods will produce different values
for the same underlying asset or company which may lead analysts to employ the technique
that provides the most favorable output.
Those interested in learning more about valuation and other financial topics may want to
consider enrolling in one of the best personal finance classes.
What Is an Example of Valuation?
A common example of valuation is a company's market capitalization. This takes the share price
of a company and multiplies it by the total shares outstanding. For example, if a company's
share price is $10, and the company has 2 million shares outstanding, its market capitalization
would be $20 million.
How Do You Calculate Valuation?
There are many ways to calculate valuation and will differ on what is being valued and when. A
common calculation in valuing a business involves determining the fair value of all of its assets
minus all of its liabilities. This is an asset-based calculation.
What Is the Purpose of Valuation?
The purpose of valuation is to determine the worth of an asset or company and compare that to
the current market price. This is done so for a variety of reasons, such as bringing on investors,
selling the company, purchasing the company, selling off assets or portions of the business, the
exit of a partner, or inheritance purposes.
The Bottom Line
Valuation is the process of determining the worth of an asset or company. Valuation is important
because it provides prospective buyers with an idea of how much they should pay for an asset
or company and for prospective sellers, how much they should sell for.
Valuation plays an important role in the M&A industry, as well as in regard to the growth of a
company. There are many valuation methods, all of which come with their pros and cons.
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PART OF
How to Value a Company
Valuing a Company: Business Valuation Defined With 6 Methods1 of 37
What Is Valuation?2 of 37
Valuation Analysis: Meaning, Examples and Use Cases3 of 37
Financial Statements: List of Types and How to Read Them4 of 37
Balance Sheet: Explanation, Components, and Examples5 of 37
Cash Flow Statement: How to Read and Understand It6 of 37
6 Basic Financial Ratios and What They Reveal7 of 37
5 Must-Have Metrics for Value Investors8 of 37
Earnings Per Share (EPS): What It Means and How to Calculate It9 of 37
P/E Ratio Definition: Price-to-Earnings Ratio Formula and Examples10 of 37
Price-to-Book (PB) Ratio: Meaning, Formula, and Example11 of 37
Price/Earnings-to-Growth (PEG) Ratio: What It Is and the Formula12 of 37
Fundamental Analysis: Principles, Types, and How to Use It13 of 37
Absolute Value: Definition, Calculation Methods, Example14 of 37
Relative Valuation Model: Definition, Steps, and Types of Models15 of 37
Intrinsic Value of a Stock: What It Is and Formulas to Calculate It16 of 37
Intrinsic Value vs. Current Market Value: What's the Difference?17 of 37
The Comparables Approach to Equity Valuation18 of 37
The 4 Basic Elements of Stock Value19 of 37
How to Become Your Own Stock Analyst20 of 37
Due Diligence in 10 Easy Steps21 of 37
Determining the Value of a Preferred Stock22 of 37
Qualitative Analysis23 of 37
How to Choose the Best Stock Valuation Method24 of 37
Bottom-Up Investing: Definition, Example, Vs. Top-Down25 of 37
Financial Ratio Analysis: Definition, Types, Examples, and How to Use26 of 37
What Book Value Means to Investors27 of 37
Liquidation Value: Definition, What's Excluded, and Example28 of 37
Market Capitalization: What It Means for Investors29 of 37
Discounted Cash Flow (DCF) Explained With Formula and Examples30 of 37
Enterprise Value (EV) Formula and What It Means31 of 37
How to Use Enterprise Value to Compare Companies32 of 37
How to Analyze Corporate Profit Margins33 of 37
Return on Equity (ROE) Calculation and What It Means34 of 37
Decoding DuPont Analysis35 of 37
How to Value Private Companies36 of 37
Valuing Startup Ventures37 of 37
Related Terms
Relative Valuation Model: Definition, Steps, and Types of Models
A relative valuation model is a business valuation method that compares a firm's value to that of
its competitors to determine the firm's financial worth. more
What Is Asset Valuation?
Relative Valuation Model: Definition, Steps, and Types of Models
Investment Theme Stockmarket and Finance Business Analysis Stockmarket With Digital Tablet
How to Choose the Best Stock Valuation Method
Debt-to-Equity Ratio Definition
Analyzing the Price-to-Cash-Flow Ratio
Close up of female accountant or banker making calculations. Savings, finances and economy
concept
How Is Terminal Value Discounted?
What Is Asset Valuation? Absolute Valuation Methods, and Example
Terminal Value
Terminal Value (TV) Definition and How to Find The Value (With Formula)
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Types of Evaluation:
Formative Evaluation: Conducted during the planning and implementation stages to provide
feedback for improving program design, implementation strategies, and operational processes.
Summative Evaluation: Conducted at the end of a program or project to assess its overall
effectiveness, outcomes, and impacts against predetermined goals and objectives.
Process Evaluation: Focuses on understanding how a program or intervention is implemented,
including fidelity, dosage, reach, and participant responsiveness.
Outcome Evaluation: Examines the immediate, intermediate, and long-term outcomes of a
program or intervention to determine its effectiveness in achieving desired results.
Impact Evaluation: Assesses the broader societal or systemic changes attributable to a program
or intervention, beyond the immediate outcomes.
Citation: Weiss, C. H. (1998). "Evaluation: Methods for studying programs and policies." Upper
Saddle River, NJ: Prentice Hall.
Key Steps in the Evaluation Process:
Identifying Purpose and Scope: Clarify the evaluation's purpose, objectives, scope, and
stakeholders' needs and expectations.
Developing Evaluation Questions: Formulate clear, specific, and relevant evaluation questions
aligned with the program's goals and objectives.
Selecting Evaluation Designs: Choose appropriate evaluation designs and methodologies
based on the evaluation questions, context, resources, and data availability.
Data Collection: Collect relevant data using a combination of qualitative and quantitative
methods, such as surveys, interviews, observations, document review, and secondary data
analysis
Data Analysis: Analyze and interpret the collected data using appropriate statistical and
qualitative analysis techniques to draw conclusions and make evidence-based
recommendations.
Reporting and Utilization: Prepare evaluation reports that communicate findings, conclusions,
and recommendations effectively to stakeholders, and facilitate their use for decision-making,
learning, and improvement
Evaluation is a dynamic and iterative process that requires collaboration, transparency, and
responsiveness to stakeholders' needs and contexts. By following these key steps and utilizing
appropriate methodologies, evaluators can generate valid, reliable, and actionable evidence to
inform program improvement, policy development, and organizational learning.
