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This part consists of nine chapters (Chapters 6–14) dealing with valuation and analysis. This section begins with a discussion of financial statement analysis and forecasting followed by chapters on fundamentals of equity valuation, company analysis, and technical analysis. The discussion then turns to examining various valuation methods including discounted dividend valuation, free cash flow valuation, market-based valuation, residual income valuation, and private company valuation.

Chapter 6 Financial Statement Analysis and Forecasting (Somnath Das and Shailendra Pandit) This chapter discusses using financial statements for forecasting in financial markets. Based on a common stock valuation formula, the chapter focuses on forecasting future stock prices and earnings for a business entity. Evidence on the predictability of stock prices or earnings has important implications for both asset pricing models and investment strategies. The chapter provides a brief survey of the literature on using technical analysis, fundamental analysis, and time series analysis for forecasting stock prices and earnings while highlighting the challenges faced by forecasters as well as strategies for improving the forecasts. The discussion primarily focuses on forecasts, including a discussion of earnings forecasts, concerning U.S. firms using financial statements. The chapter also discusses some limitations of using financial statement analysis in forecasting.

Chapter 7 Fundamentals of Equity Valuation (Emmanuel Boutron, Alain Coën, and Didier Folus) Equity valuation refers to a key economic metric that represents a company's net worth. Numerous practitioners and academics use and study equity valuation. The main stakeholders involved in a company's net worth are stockholders, banks, and bondholders, who are directly interested in the company's intrinsic value. Financial executives and clients are indirectly concerned. Different approaches are available to evaluate a company's equity, including discounted cash flow (DCF)-based valuation, market-based valuation, and option-based valuation. The DCF approach is based on the firm's expected free cash flow or on futures dividends. Using the DCF approach implies using fundamental analysis of the company's business and financial statements to forecast its cash flow, which should be discounted at a risk-adjusted rate of return. Investors and analysts can use various asset pricing models, such as the capital asset pricing model, to calculate the required rate of return used in the equity valuation process. Practitioners often use market-based approaches, including multiples and ratios, because such approaches are cost-effective and enable making comparisons among companies. This chapter highlights the crucial role of equity valuation in modern finance for both academics and practitioners.

Chapter 8 Company Analysis (David Craig Nichols) Company analysis refers to the analysis of a company's financial statements and other information to better understand its profitability, growth, and risk. This chapter develops a company analysis in the context of a three-step framework for understanding the relation between business activities and stock prices. The first step maps business activities into financial statements through the financial reporting process. The second step maps financial statements into forecasts and estimates of share value through the fundamental analysis process. The third step maps equity values into share prices through the trading process. The chapter focuses on accounting analysis and ratio analysis, including profitability, growth, liquidity, solvency, and financial distress, but describes the role of financial statements in equity valuation more generally.

Chapter 9 Technical Analysis (David Lundgren) This chapter demonstrates the underappreciated philosophical link between technical analysis and fundamental analysis illustrated using Dow Theory. Specifically, the linkage between the two types of analysis on the relative performance of a company's share price is mainly dependent on the company's fundamental strength. This chapter also investigates several technical strategies, including trend following and cross-sectional momentum, used today by technical and fundamental investors alike, to improve their stock selection and timing decisions. Further, it also examines techniques for determining the health of broad market trends, thus equipping investors with the skills needed to assess the overall risk environment.

Chapter 10 Discounted Dividend Valuation (Elif Akben-Selçuk) This chapter explores the dividend discount model (DDM), which defines the value of common stock as the present value of expected future dividend payments. It investigates both the constant growth model (also called the Gordon model), which assumes a steady-state rate for the firm forever. The chapter also examines multi-stage models, including the two-stage model, H-model, and three-stage model, which assume a multiple-stage growth for dividends and earnings. Besides these traditional models, the chapter considers binomial and trinomial stochastic DDMs and the uses of DDMs. Finally, it discusses the results of empirical studies testing the relevance and practical significance of DDMs.

Chapter 11 Free Cash Flow Valuation (Tom Barkley) Valuation analysis lies at the heart of finance. It tries to ascertain the true worth of assets, securities, companies, and projects. Absolute valuation approaches rely on fundamental analysis to estimate a firm's intrinsic value based only on its characteristics. By contrast, relative valuation methods rely on multiples associated with comparable companies, based on a firm's characteristics relative to its peers. Regarding the former approaches, the most commonly used is a discounted cash flow (DCF) analysis, which forecasts a firm's future cash flows and discounts them at an appropriate rate to obtain their present values, whose sum is then the firm's value. This chapter highlights four special cases of DCF analysis: (1) the weighted average cost of capital approach; (2) the adjusted present value method; (3) the capital cash flow model; and (4) the free cash flow to equity technique.

Chapter 12 Market-Based Valuation (Sang Hoon Lee) The purpose of this chapter is to introduce a valuation method using market-based multiples and discuss the advantages and challenges of using this method. Practitioners widely use market multiples such as equity-related or enterprise value (EV)-related multiples. This valuation method has distinctive benefits over the fundamental valuation approach, offering a potential reduction of biases from estimating future cash flows and discount rates. The rationale for using market multiples for valuation is the principle of substitution for equally valuable assets. Therefore, selecting comparable companies that closely match the target company is the key to success for improving valuation accuracy as the benchmark multiples are drawn from these companies. Since different multiples and value drivers produce dissimilar valuation estimates, choosing the most effective multiples or a combination of them with theoretically consistent measures in the composition of a multiple is essential. Equity researchers and practitioners often propose using a harmonic mean of different multiples to minimize valuation errors. Also, forward performance measures usually produce more accurate value estimates. However, controversy remains about the efficacy of various multiples.

Chapter 13 Residual Income Valuation (Shailendra Pandit and Somnath Das) This chapter reviews the concept of residual income (RI) and its application in equity valuation. RI is surplus profits generated by a project after accounting for the cost of capital invested in the project. RI has its roots in the concept of opportunity cost: To create value for investors, an investment project must generate returns above the opportunity cost of the invested capital. From its roots in the emergence of modern economic thought, RI evolved as a formal valuation approach in the twentieth century. The impetus for broader adoption of RI came not only from accounting and finance scholars but also from valuation and strategy consultants who played a crucial role in popularizing the concept among business organizations. Computing RI involves using a clean surplus relation to adjust and remove potential biases from financial statement numbers, forecast growth in those amounts, and compute the opportunity cost of equity. Today, RI is widely used in capital budgeting, operational planning, performance evaluation, executive compensation, and equity valuation.

Chapter 14 Private Company Valuation (Onur Bayar and Yini Liu) This chapter reviews the application of different valuation methods for evaluating investment opportunities in private companies. It focuses on the underlying fundamentals of each method, when each technique is appropriate, and how some applications differ between privately held and publicly traded companies. The chapter also discusses the following valuation methods in the context of private equity (PE): discounted cash flow, comparable firm valuation, the venture capital method, and option pricing. A thorough understanding of these methods enhances the ability to make value-increasing decisions in a PE setting. Although the chapter discusses some strengths and weaknesses of each method in private company valuation, it also highlights the connections among them and how they can complement each other to help entrepreneurs, investors, and analysts make better investment decisions and evaluations.