The choice of the valuation model is also dependent on the stage of the life cycle to which the company’s operations belong to. Correspondingly, it is easier to apply the models of Dividend Discounting Approaches to mature companies, rather to the start-ups that are characterized by almost negligible dividend pay-outs. A model that is deemed to be applicable in all scenarios is the DCF approach. The model is flexible enough that facilitates its application to various companies in various stages of the life cycle (whether they are dividend paying or not). It is also suitable for companies that have diversified business lines. Yet, the complication lies in its necessity of providing various estimates which are inputted in the model so as to arrive at the values of the true potential of the security. On account of its judgmental behavior, this model yields various estimates as and when it is applied by various analyst groups (Platt & Platt, 2009). This model facilitates to account for the cash flows at various time periods, and is a method aiming at valuation over a multi period time horizon. Besides this, it accounts for cash flows, instead of earnings, which is beneficial as earnings are highly susceptible to manipulation (as was evident in the case of Enron). Cash flows are less susceptible to manipulation and thus provide reliable estimates of the value.
Analysts have also come up with various other innovative models which focus on determining the value of the equity of the company and adding the market value of debt in order to obtain an estimate of the total value of the firm (Security Analysis, 2011). The market value of debt is easily observable from the term structure of interest rates, but the value of equity cannot be ascertained easily. Thus, to improve the accuracy and robustness of the methods of equity valuation, option pricing models are applied in which the equity of a company is valued as per the payoffs of the call option, in which the underlying security is the firm’s asset base and the call option’s exercise price is the value of the company’s debt. Moreover, as analysts aim to value private companies and securities which are not frequently traded, models based on relative valuation approaches are generally used.