Economic Analysis
The very first step in the equity valuation approach is related to the economic analysis as an existing economic environment has a substantial effect on the performance of a firm. The economic environment of a nation is mainly driven by fiscal and monetary policies which through their respective tools decide the direction of economic growth. In addition, other factors such as inflation rate, political turmoil and international monetary devaluations also affect the existing economic condition of a nation followed by corresponding effect on the industries operating in that particular nation.
Industry Analysis
The second step in the equity valuation approach is related to the analysis of the industry that will prosper or get worse amid the existing economic conditions. It is noteworthy that different industries react in varied manner at different business cycle. For Instance, cyclical industries such as steel and auto perform better than the aggregate economy during economic peaks and suffer more during slow- down. Another factor to be considered during industry analysis is the presence of firms in the industry in international market. For Instance, if most of the firms in the industry have wide international exposure, they can still benefit from the growth in the alien economy when demand is low in domestic market.
Company Analysis
This is the last step in the equity valuation approach under which, after analyzing the economic and industry, investors can analyze and select the company for evaluation of their cash flows and financial ratios. Investor would always prefer a best company and that too in a promising industry and will only include it in its portfolio after considering other factors such as correlation with other asset classes.
