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Absolute Value Definition
An absolute value has different meanings in different contexts. In business, an absolute value refers to a valuation method used in measuring the financial status or strength of a company. This method of business valuation uses Discounted Cash Flow (DCF) in assessing the wealth of a company.
It is important to note that the absolute value of a business differs from its relative value. While an absolute value examines a company’s wealth using the time value of money and accumulation of interest, relative value models gauge a company’s wealth by comparing it to its competitors’ wealth.
A Little More on What is Absolute Value
Absolute value methods aim to measure the financial worth of a company using its inherent values or expected future cash flows. There are a number of ways through which value investors examine whether a stock is undervalued or overvalued. These methods include price to earnings (P/E), price to book ratio as well as discounted flow analysis method. The future cash flows of a company is central to the DCF valuation method.
The projected cash flows of a company are discounted to the present value, this is how the absolute value is realized. The absolute value of a company is essential in helping investors determine whether stocks owned by the company are being undervalued or overvalued.
There are many methods of business valuation that are subsets of the DCF model, these methods use discounted rates when measuring the cash flow in order to get the company’s absolute value. Some of these methods are dividend discount model (DDM), discounted FCF model and discounted asset model.
There are many drawbacks on calculating a company’s absolutes value, the processes are not always smooth. For instance, predicting a company’s accurate growth is often difficult, estimating an appropriate discount rate for the present value is also not without challenges.
Unlike some other business valuation methods that draw comparison between the worth of a company’s stock and that of competitors, the absolute value draws no comparison. Rather, it estimates a company’s financial worth based on the inherent values of the company.
Reference for “Absolute value”
Academic research on “Absolute research”
Equity valuation employing the ideal versus ad hoc terminal value expressions, Courteau, L., Kao, J. L., & Richardson, G. D. (2001). Equity valuation employing the ideal versus ad hoc terminal value expressions. Contemporary accounting research, 18(4), 625-661. This study investigates the potential impact of equity valuation on stock prices. The authors first analyze the previous study conducted by Penman and Souigiannis (1998) and Francis et al (2000) who found that residual income model (RIM) outperforms discounted cash flow model (DCF) in the case of non-price-based terminal values. The main objective of the study is to understand whether DCF and RIM have empirical equivalence when ‘ideal’ terminal value expressions are used in each model. In this case, the authors find empirical support for the equivalence between the valuation models. The second objective the authors considered is whether Value Line forecasted price in the terminal value expression can generate low prediction errors compared to the non-price-based terminal values. In this case, results of the study indicate that price-based valuation models outperform non-price-based models in both DCF and RIM.
[PDF] Application of the value based management approach to assess the effectiveness of business assets control, Iakovleva, E., & Bychaev, Y. (2011). Application of the value based management approach to assess the effectiveness of business assets control. In WEST-OSTREPORT International Forum for Science and Research (No. 2, pp. 63-72). This study investigates the effectiveness of business asset control using the value based management approach. According to the authors, the main methodological problem association with the evaluation of a company’s economic efficiency and the economy as a whole is to locate efficient resources within the company. The use of a value based management (VBM) approach to assess the effectiveness of business assets depends on several factors including human capital, cost of capital, taxes, innovation, and intellectual property. While some of the elements such as capital and income are deterministic in nature, others are probabilistic. For instance, these include revenues from future innovations with multiplicative character and lifecycle of up to 55-60 years. Furthermore, intangible assets and intellectual property must be considered in regard to future benefits as well as factors that increase the asset value of a company.
Conditions that the roots of a polynomial be less than unity in absolute value, Samuelson, P. A. (1941). Conditions that the roots of a polynomial be less than unity in absolute value. The Annals of Mathematical Statistics, 12(3), 360-364. This article uses mathematical formula to prove that the roots of a polynomial are less than unity in the absolute value. Paul Samuelson asserts that in econometric business cycle analysis, the theory of probability and numerical mathematical computation of convergence of repeated iterations arise. The difference equations can be shown to be stable in the sense of converging to a limit if certain associated polynomial has roots whose moduli are less than unity. The author further presents equations to prove the ideology of value of unity.
Structure-profit relationship at the line of business and industry level, Ravenscraft, D. J. (1983). Structure-profit relationship at the line of business and industry level. The Review of Economics and Statistics, 22-31. This article discusses the existing relationship between structure and profit in the business and industry level. According to the author, there is a gap in the industrial literature addressing whether profits rise as industry concentration increases while all other structural variables remain constant. Also, it remains unclear to what economic phenomena underlie the existing positive relationship between market share and positive profit. These limitations, however, ae overcome by the Federal Trade Commission’s Line of Business survey which collects data disaggregated to the “line of business” (LB). LB is a concept that refers to the operations of a firm in one of 261 manufacturing and 14 non-manufacturing categories as defined by FTC.
[PDF] An almost absolute value in history, Noonan, J. T. (1970). An almost absolute value in history. The morality of abortion: Legal and historical perspectives, 1, 1-59. This article uses the concept of absolute value to determine the morality of abortion. The author argues that the concept of viability can be used to address the contemporary controversy over legalizing abortion. Before the fetus develops many months, it is not viable i.e. it cannot be removed from the womb and live apart from the mother. In this case, the fetus is absolutely dependent on the life of a mother. This dependence forms the basis of denying recognition to its humanity. However, this argument has limitation. First, there is the perfection of artificial incubation which makes the fetus viable at any period. This approach has been proven by experiments involving animals. The author denotes that the viability of the fetus depends on the extent of its functional and anatomical development. The length and weight of the fetus guides its development, but there is variation in weight and length.