Equity valuation using accounting numbers in high and low market cap companies

Most firms’ and individual analysts’ decisions depend on information obtained by valuation to make assessments. The several factors influencing that same valuation process are not always straightforward, and a small difference in methodologies used, time period considered or even assumptions made, can dictate a difference in the agent’s economic decisions. The present dissertation proposes to ascertain which models of equity valuation based on figures from accounting procedures put up a better alternative on explaining market prices when a market capitalization division (small/large) is put in place. Four different methodologies are compared in terms of efficiency, usability and limitations, two of those being stock-based models while the other two flow-based ones. A literature review is firstly conducted to identify previous research on the matter, highlighting the superior theoretical background of flow-based methods, especially the RIVM and OJ Model, due to their attractiveness to the use of the net income figure rather than a derivation. On the following section, a large sample examination is performed, with an analysis of errors, explanative power, sensitivity to small variable changes and even industry sub-divisions. Using the market price as reference, the Price to earnings multiple model has yielded the best results across the board, despite the differences in performance found across the divisions implemented. Also, a small sample analysis is conducted, in which a set of forty broker’s reports is chosen to ascertain if the small/large market cap division is also considered by practitioners when issuing recommendations. Although some differences are found, the main dissimilarity seems to be more closely related to the brokerage houses own preferences than to firm size, but inherit limitations on this type of analysis do not allow for definite conclusions