For my finance class, I have to write a 3 page paper on why comps are considered one of the most important tools for financial analysis and valuation.
Can anyone give me some tips? Sorry if this sounds stupid
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Tip: think about the deficiencies/assumptions of other models. DCF, etc. What can cause other methods to be inaccurate?
Tip2: how do comps point you towards a market consensus valuation?
Maybe I'm being too vague. Maybe not. I dont wanna kill the "fun"
Wow, that sounds like an awful paper to write that's pure busy work. Really, you're not going to learn anything writing it that will be useful a year from now other than understanding what a comp is and how it's used, which could be covered in ten minutes in class.
If it's three pages, definitely go into a little detail in the other methods, some of their drawbacks, and I'd google the topic and cite some examples of when comps worked better than the other methods (I'm sure you can find some website even devoted to this topic like "When Comps are better than DCF.") You could mention the fact that using comps allows you to tailor valuation for the industry rather than just projecting firm-specific future growth (there are obvious drawbacks to comps as well though).
You can tailor a DCF to have any valuation you want - you have to forecast both FCF and WACC very accurately for DCF analyses to yield any value.
DCFs only consider the value of FCFs. There are other things that can drive up the price of a stock (earnings predictability, stock's liquidity)
Market comps technically take into account of all of this and more (the market sentiment / psychology).
If it's a specialized company, there probably won't be any similar comps in the market. Thus you must calculate the value using other weighted methods
It is indeed a very silly question. But such is academia. So here's an academic answer:
PROS It gives perspective (most obvious) Fairly easy to compute and interpret
CONS Does not take into account industry declines (if your comparables are in 1 industry for example) Often fails. This is just my personal opinion as I'm just a cynic like that
DCF is a joke. I don't know anyone on the buyside who uses it seriously. Everyone uses comps.
Very very true. It's simply too bullshit-soluble. DCF is really only popular with project planning and other internal analyst stuff.
I don't even remember how to delever beta or calculate WACC anymore. Anyone who pitches an idea to me which is based on equity value calculated via a DCF gets a bertstare from me.
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