Fundamental Valuation Models to Know for Finance

Fundamental Valuation Models are essential tools in Finance for determining the worth of investments. These models, like DCF and DDM, help assess future cash flows, dividends, and overall company performance, guiding investors in making informed decisions.

1. Discounted Cash Flow (DCF) Model

   • Estimates the value of an investment based on its expected future cash flows.
   • Cash flows are discounted back to their present value using a discount rate, typically the weighted average cost of capital (WACC).
   • Useful for valuing companies with predictable cash flows and long-term growth potential.

2. Dividend Discount Model (DDM)

   • Values a stock by predicting future dividends and discounting them back to present value.
   • Assumes that dividends will grow at a constant rate indefinitely.
   • Best suited for companies that pay regular and stable dividends.

3. Free Cash Flow to Firm (FCFF) Model

   • Calculates the value of a firm based on the cash flows available to all capital providers (debt and equity).
   • Focuses on cash generated from operations after capital expenditures.
   • Useful for valuing companies regardless of their capital structure.

4. Free Cash Flow to Equity (FCFE) Model

   • Values a company based on the cash flows available to equity shareholders after all expenses, reinvestments, and debt repayments.
   • Provides a clearer picture of the cash available for dividends and share buybacks.
   • Ideal for companies with significant debt or varying capital structures.

5. Residual Income Model

   • Values a company based on the income generated above the required return on equity.
   • Focuses on the profitability of a firm after accounting for the cost of equity capital.
   • Useful for companies that do not pay dividends or have irregular cash flows.

6. Comparable Company Analysis (Multiples)

   • Values a company by comparing it to similar firms in the industry using valuation multiples (e.g., P/E, EV/EBITDA).
   • Provides a market-based perspective on valuation.
   • Useful for quick assessments and benchmarking against peers.

7. Adjusted Present Value (APV) Model

   • Values a firm by separating the value of operations from the value of tax shields due to debt.
   • Considers the impact of financing decisions on overall value.
   • Useful for firms with complex capital structures or significant tax benefits.

8. Gordon Growth Model

   • A specific type of DDM that assumes dividends grow at a constant rate indefinitely.
   • Simplifies the valuation process for stable, mature companies.
   • Best used when a company has a predictable dividend growth rate.

9. Asset-Based Valuation

   • Values a company based on the net asset value of its tangible and intangible assets.
   • Useful for companies with significant physical assets or in liquidation scenarios.
   • Provides a floor value for a company, especially in asset-heavy industries.

10. Economic Value Added (EVA) Model

    • Measures a company's financial performance based on residual income after deducting the cost of capital.
    • Focuses on value creation and operational efficiency.
    • Useful for assessing management performance and strategic decision-making.