What is 'Relative Value'

Relative value is a method of determining an asset's value that takes into account the value of similar assets. This is in contrast with absolute value, which looks only at an asset's intrinsic value and does not compare it to other assets. Calculations that are used to measure the relative value of stocks include the enterprise value (EV) ratio and price-to-earnings (PE) ratio.

BREAKING DOWN 'Relative Value'

When value investors are considering which stocks to invest in, they do not just look at the financial statements of the companies in which they are interested. They also look at the financial statements of competing companies – along with relevant footnotes, management commentary, and industry and economic data – to assess the stock's value, relative to its peers.

Steps in relative valuation may include:

  • First, identifying comparable assets and/or corporations. In these cases, it can be useful to view market capitalizations and revenue or sales figures. The market values for comparable companies can be viewed as their stock prices, or where the general public has priced them.

  • Deriving price multiples from these initial figures. Price multiples can include ratios, such as price-to-earnings (PE), price-to-sales (PS), or value/EBIT.

  • Comparing these multiples across a company’s peer or competitor group to determine an over- or under-valued security.

Example of Relative Value Analysis Results

An example of a relative value analysis results for Microsoft Corporation (MSFT):

Company

Market Capitalization (millions)

Net Income (millions)

Price-to-earnings (PE) ratio

Microsoft

$666.154

$22.113

30.5

Oracle

$197.500

$9.913

20.5

VMWare

$52.420

$1.186

46.8

Based on the above relative value analysis results, despite some variations in company sizes, Microsoft is overvalued, relative to Oracle; yet undervalued, relative to VMWare.

Relative Versus Intrinsic Valuation

Relative valuation is one of two important methods of placing a monetary value on a company; the other is intrinsic valuation. Investors might be familiar with the Discounted Cash Flows (DCF) method for determining the intrinsic value of a company. While relative valuation incorporates many multiples (above), a DCF model uses a company’s future free cash flow projections and discounts them. This is done, using a required annual rate. Eventually, an analyst will arrive at present value estimate, which can then be used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.

RELATED TERMS
  1. Valuation

    A valuation is process of determining the current worth of an ...
  2. Relative Valuation Model

    A relative valuation model is a business valuation method that ...
  3. Modified Book Value

    Modified book value is an asset-based method of determining how ...
  4. Breakup Value

    The breakup value is the sum-of-parts value of a publicly traded ...
  5. Return on Market Value of Equity ...

    Return on market value of equity (ROME) is a measure used to ...
  6. Hidden Values

    Hidden values are assets that are undervalued on a company's ...
Related Articles
  1. Investing

    How to Identify Mispriced Stocks

    Find out how to identify mispriced stocks. Learn about intrinsic and relative valuation methods based on fundamentals, and technical analysis.
  2. Investing

    How to choose the best stock valuation method

    There are many valuation methods available to investors, each with unique characteristics. Here, we'll explore the most common valuation methods – and when to use them.
  3. Investing

    What Is The Intrinsic Value Of A Stock?

    Intrinsic value can be subjective and difficult to estimate. It’s a perception of a security’s value that factors tangible and intangible factors.
  4. Investing

    Here's How Relative Valuation Can Be a Trap

    Valuing a company through relative valuation to identify low-priced companies with strong fundamentals can make for deceiving looking bargain stocks.
  5. Investing

    How to value companies with negative earnings

    For some investors, the possibility of stumbling upon a small biotech with a potential blockbuster drug, or a junior miner with a giant mineral discovery, makes the risk of investing in companies ...
  6. Investing

    Peer Comparison Uncovers Undervalued Stocks

    Learn how to put one of the top equity analysis tools to work for you.
  7. Investing

    What Is The Value In Value Investing?

    Value investing has its advantages, but it also has significant drawbacks. We look at the pros and cons.
RELATED FAQS
  1. When does a growth stock turn into a value opportunity?

    Learn how fundamental analysts use valuation measures, such as the price-to-earnings ratio, to identify when a growth stock ... Read Answer >>
  2. What is the difference between enterprise value and equity value?

    Valuating a business accurately depends heavily on the purpose of the valuation. Learn how enterprise value and equity value ... Read Answer >>
  3. How Are Book Value and Market Value Different?

    Book value and market value are two financial metrics used to determine the valuation of a company and whether the stock ... Read Answer >>
  4. What value metrics are best for analyzing companies in the metals and mining sector?

    Learn what some of the best valuation measures are that analysts commonly use to evaluate companies in the metals and mining ... Read Answer >>
Hot Definitions
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  6. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
Trading Center