equity valuation

The purpose of fundamental analysis is to identify stocks that r mispriced relative to some mearsure of true value that can be derived from obervalbe financial data. a clear example of mispricing occurs when there is violation of the law of one price (mentioned in last artical).

some firms sell stock at a market value above book value, some are opposite. can book value represent a floor for the stock price? a better measure of a floor for stock price is the liquidation value per share. this represents the amount of money that could be realized by breaking up the firm, selling its asset, repaying its debt and distributing the remiander to its shareholders.  the reasoning behind this concept is that if the market price drops below the liquidation value of the firm, the firm becomes attarctive as a takover target.

another balance sheet concept that is of interest in valuing a firm is the replacement cost of its assets less its liabilites. the competitive pressure of other similar firms entering the same industry would drive down the market value of all firms until they came into equallity with replacment cost.

although focusing on the balance sheet can give some useful info about a firm's liquidation value or replacement cost, the analyst must usually turn to expected future cash flows for a better estimate of its value as a going concern.

let me discuss the quantitative models that analyst use to value stock in terms of the future earnings and dividends later.