Absolute Value - Explained
What is Absolute Value?
Written by Jason Gordon
Updated at October 10th, 2021
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What is Absolute Value?
An absolute value has different meanings in different contexts. In business, an absolute value refers to a valuation method used in measuring the financial status or strength of a company. This method of business valuation uses Discounted Cash Flow (DCF) in assessing the wealth of a company. It is important to note that the absolute value of a business differs from its relative value. While an absolute value examines a company's wealth using the time value of money and accumulation of interest, relative value models gauge a company's wealth by comparing it to its competitors' wealth.
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How Does Absolute Value Work?
Absolute value methods aim to measure the financial worth of a company using its inherent values or expected future cash flows. There are a number of ways through which value investors examine whether a stock is undervalued or overvalued. These methods include price to earnings (P/E), price to book ratio as well as discounted flow analysis method. The future cash flows of a company is central to the DCF valuation method. The projected cash flows of a company are discounted to the present value, this is how the absolute value is realized. The absolute value of a company is essential in helping investors determine whether stocks owned by the company are being undervalued or overvalued. There are many methods of business valuation that are subsets of the DCF model, these methods use discounted rates when measuring the cash flow in order to get the company's absolute value. Some of these methods are dividend discount model (DDM), discounted FCF model and discounted asset model. There are many drawbacks on calculating a company's absolutes value, the processes are not always smooth. For instance, predicting a company's accurate growth is often difficult, estimating an appropriate discount rate for the present value is also not without challenges. Unlike some other business valuation methods that draw comparison between the worth of a company's stock and that of competitors, the absolute value draws no comparison. Rather, it estimates a company's financial worth based on the inherent values of the company.