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Valuation methods - Coggle Diagram

- - - - Limits
        
        Dividend payments are distribution of value and not creation of value "Dividend conundrum" (Penman 1961)
        
        Forecasting dividends over finite horizon does not give indication of value as value of equity is based on future dividends. Therefore, dividend policy does not affect firm value (MM 1961)
        
        Dividends reaching constant growth or stable are hard to forecast given different time periods
        
        Sustainable stable growth rate is difficult to determine
    - - Advantage
        
        Suitable for Mature industries producing constant positive or constant growth in FCF
        
        Important for firms with high leverage or if leverage expected to significantly change as estimation of future debt and repayment is complex
        
        Acts as comparison of leverage between firms
        
        No need to forecast cashflow for debt
      - Lmits
        
        FCF not a good indicator or Profit as ROCE uncorrelated with FCF
        
        FCF not a good indicator for PB and PE as ROCE varies with PB and PE while PB and PE is uncorrelated with FCF
        
        Decrease in FCF due to reinvestments in future growth not captured by discounting process
  - - - Advantages
        
        Focus on profitability(ROCE,RNOA) and growth in investment (g=b x ROE)
        
        Forecast horizon to continuing value shorter is there is mean reversion
        
        AE not affected by accounting choices if forecast significantly robust
        
        Aligns with analyst focus on earnings
      - Limits
        
        Forecast horizon is inversely dependant on quality of accrual accounting
        
        When applied to consulting, advising and valuation practices, proliferation and variation can be seen in the model.
    - - EVA
        
        Expenditure on future growth i.e R&D, Marketing, training costs are expensed immediately as operating cost instead of intangible asset therefore understating NOA
        
        EVA addresses distortions from accounting conservatism by adding expenses back to NOPLAT capitalising expenditures as part of invested capital
    - - AE Method only applies to equity, Aoi method applies only to operating activities
        
        Accounting effects do not affect valuation under AE model as PVAE remains the same across periods, Under EVA, Adjustments are required to undo accounting effects on FS data