Equity valuation models are used to estimate the intrinsic value of an equity security. By comparing the intrinsic value and market price, an analyst can draw one of three conclusions: the security is undervalued, fairly valued, or overvalued. Investment decisions are then made based on the comparison.

There are two uncertainties in this process:

• Which valuation model should we use?
• Are the inputs to be used in the model appropriate?

Analysts often use more than one valuation model because of concerns about the applicability of any particular model and the variability in estimates that result from changes in inputs.

The model should be kept as simple as possible. The goal is to minimize the inaccuracy of the forecast.

There are three major categories of equity valuation models:

• Present value models. Both dividend discount models and free-cash-flow-to-equity models belong to this category.
• Multiplier models. These are relative valuation models.
• Asset-based valuation models. These are based on the book value of assets and liabilities.