As has been discussed above, the aim for valuation determines the choice of the valuation model used. When the valuation model seeks to determine the value of the company which is a potential take over target, the models applied account for the expected synergistic benefits of the deal also and as such, models like Free Cash Flow to Firm are used which ignores the financing patterns of the company and determines the value of its operating activities and profits from operations. On the other hand, if an institutional investor is valuing the company to include it in their portfolio, their valuation approach would be completely different, which would focus on the correlation of the returns of the security with the investor’s portfolio and identify the returns that accrue to a small retail investor, who does not possess a strategic stake in the company, through methods like Dividend Discount Model, etc.
Analysts are often confronted with a wide gamut of potential investments and in such situations, if they apply the discounted cash flow valuations methodology for each and every security, the process may be very time consuming as determination of the values of the inputs is an extremely challenging task and accurate estimates require substantial time and efforts on the part of the analyst. Though the advent of IT has simplified the process of making computations, the estimates are arrived at, only after the exercise of judgment by the analysts and this process cannot be completely automated. Thus, screening on an initial basis is done by the analysts in a speedier manner through the application of relative valuation models.