In this article, let's take a look at the process of determining the value of an asset, refer as valuation. There are several approaches (absolute valuation models, relative valuation models and the method of comparables), and the analyst´s ability is crucial in this process. If the analyst has a complete understanding of the characteristic of the asset, what he is determining is the intrinsic value of the asset.
If the efficient market theory exists, then the best estimation of the intrinsic value of a security is its price. But we all know that stock prices are not perfectly (informationally) efficient, so the trading price diverges from the intrinsic value; this is called mispricing. And here the ability of the analyst to produce positive risk-adjusted return, sometimes called abnormal return or alpha, is crucial. Continue Reading »