Which of the following is least likely to be identified as a relative valuation model? Select one:
A. H model.
B. PEG.
C. PS.
D. PE.
The correct answer and explanation is:
The correct answer is: A. H model
Explanation:
Relative valuation models are methods used to value a company by comparing it to other similar companies or industry benchmarks using valuation multiples. These models typically rely on ratios that relate a company’s market value to some fundamental metric such as earnings, sales, or growth. Common relative valuation multiples include:
- P/E (Price-to-Earnings) ratio: Compares the company’s stock price to its earnings per share.
- P/S (Price-to-Sales) ratio: Compares the company’s stock price to its revenue per share.
- PEG (Price/Earnings to Growth) ratio: Adjusts the P/E ratio by the company’s earnings growth rate, giving a sense of valuation relative to expected growth.
All three of these (PE, PS, PEG) are classic examples of relative valuation models because they value a company by comparing its multiples to those of other companies or the industry average.
What is the H Model?
The H Model is a type of discounted cash flow (DCF) model, not a relative valuation model. It is a hybrid dividend discount model that is used to estimate the value of a stock by assuming a gradual transition from a higher initial growth rate to a stable, lower long-term growth rate. The H Model captures a changing growth rate over a specific period, blending a high-growth phase with a mature phase.
Because the H Model relies on forecasted dividends and intrinsic value calculations, it is considered an intrinsic valuation model, not a relative valuation model. It looks at the company’s own projected cash flows rather than comparing multiples to other companies.
Summary:
- Relative valuation models (P/E, P/S, PEG) use market multiples compared against peers or benchmarks.
- The H Model is a discounted cash flow (intrinsic) valuation model, based on estimating present value of future dividends.
- Thus, the H Model is least likely to be identified as a relative valuation model.