Mispricing can be explained by the sum of the two components: true mispricing and estimation error
Ve – P = (V – P) + (Ve – V)
If the asset is expected to benefit the owner in the foreseeable future, the valuation of the asset is carried out on a going concern basis and the value of the asset is called going concern value.
The value of an asset is called fair market value if the value is determined in a trading transaction between willing and knowledgeable parties (buyers and sellers) when parties are not under any compulsion to engage in the buying or selling activities.
In many circumstances assets are worth more than their fair market value to a particular buyer because of their specific benefits to that buyer. These benefits are usually called synergy effects. The difference between fair market value and the price paid for the asset is called "goodwill" in accounting terms.
The process for equity valuation begins with business understanding. Analysts who are going to value equity of a particular company must carefully analyze the industry and the market the company is operating in while also answering the following questions: Is the industry the company is operating in vulnerable to business cycles? What are the primary competitors and market share of the company being valued? What are the future trends of the sales of the company? What are the main value drivers? usually done by applying Porter’s five forces analysis.
forecast: top down, bottom up
Equity valuation models can be classified into two broad categories: absolute valuation models and relative valuation models. Absolute valuation models are designed to estimate intrinsic value of an asset based on either its future benefits or market values. The absolute models are further divided into two categories: present value models and asset-based valuation models. There are three groups of models under present value models: dividend discount models, free cash flow models and residual income models.
The companies that generate revenue from many unrelated segments can be better valued using sum-of the-parts valuation (sometimes called break up value or private market value).
Some researchers suggest that markets tend to value a company less than the sum of its segment values, a phenomenon called Conglomerate discount.
Possible explanations for conglomerate discounts are the following: 1) inefficient diversification by companies (diversification on the company level rather than the shareholder level does not maximize shareholders‘ wealth); 2) inability of organic growth, so companies tend to grow through acquisition; 3) mismeasurement of intrinsic value (conglomerate discount does not exist).
The difference between expected return and required return is called expected alpha (ex-ante alpha), and the difference between realized return and contemporaneous required return is called realized alpha (ex-post alpha).