The Importance of Company Valuation to Investor, the Shortcoming of DCF Mode - Literature review Example

An example of an investor who hugely benefits from company valuation is one who reinvests dividends. By this kind of re-investment, such an investor could build wealth for myriad uses such as retirement benefits. However, the core importance of company valuation to investors is that it allows them to know the value of a company and its assets before investing (Copeland et al., 2000). Familiarity with the value of a company and its assets is quite important for investors’ intelligent decision making, more so for deciding the most appropriate prices to pay or receive during a takeover (Pratt, 1998).

Additionally, valuation helps investors to choose the right investment portfolio and sound financing and dividend choices when running a business. Valuation also helps investors make reasonable estimates of the values of real and financial assets. Company valuation also ensures that an investor does not pay more for an asset than its real worth. Therefore, valuation plays several critical roles in acquisition analysis, corporate finance, and portfolio management (Pratt, 1998). Efficient Market Hypotheses Is Not Trustable Many researchers, scholars and investors have theoretically and empirically criticized and disputed the efficient-market hypothesis.

At the forefront in criticizing the efficient-market hypothesis are behavioral economists who assert that combinations of cognitive biases are responsible for the deficient nature of Efficient Market Hypothesis (EMH) (Gaughan, 2004). These cognitive biases include overreaction, information bias and representative bias, predictable human errors of reasoning, information processing errors and overconfidence. The alleged reasoning errors have been observed to drive many an investor to buy excessively expensive growth stock while avoiding value stock (Hitchnera, 2006).

On the other hand, those reasoning correctly buy and profit from the neglected value stock and the overreacted selling of growth stocks. In a similar manner to theoretical evidence, practical evidence fault the efficient-market hypothesis, For example, while some behavioral economists assert that low P/E stocks have greater returns, others tend to differ, attributing these higher returns to higher beta (?) (Gaughan, 2004). In fact, the latter group’s researches have been accepted by efficient market theorists as adequately explaining the irregularities according to the modern portfolio theory.

That stock buyers often operate on and are driven by irrational excitement implies that a lot of speculative economic bubble anomalies are encountered in the markets since such buyers do not detect the underlying values of stocks (Gaughan, 2004). After these economic bubbles, there is always an overreaction and frantic effort to sell stocks to unscrupulous investors who then buy these stocks at bargain prices. Further, since markets may remain irrational for a longer duration than expected, even rational investors could encounter difficulties to operate profitably since they may be forced to shorting irrational bubbles since they are no longer able to remain solvent over the period (Gaughan, 2004).

The Limitations of Net Asset Valuation Model Once a company gets solvent, it may decide to pay its creditors, sell its assets