What is Relative Value?

Relative value is a method of determining an asset's worth that takes into account the value of similar assets. This is in contrast with absolute value, which looks only at an asset's intrinsic value and does not compare it to other assets. The price-to-earnings ratio (P/E ratio) is a popular valuation method that can be used to measure the relative value of stocks.

Value investors examine the financial statements of competing companies before deciding where to invest their money. They look at relevant footnotes, management commentary, and economic data to assess the stock's value relative to its peers.

Steps in relative valuation may include: first, identifying comparable assets and corporations. In these cases, it can be useful to view market capitalizations and revenue or sales figures. Their stock prices represent how the market values comparable companies at any given time. Deriving price multiples from these initial figures. Price multiples can include ratios, such as the P/E ratio or the price-to-sales ratio (P/S ratio). Comparing these multiples across a company’s peer or competitor group to determine if the company's stock is undervalued relative to other firms.

Investors must always choose among the investments that are actually available at any given time, and relative valuation helps them to do that. By 2019, it was easy to look back at the prices of most U.S. stocks in 2009 and realise that they were undervalued. However, that does not help one to choose better investments today. That is where a relative valuation method like the stock market capitalization-to-GDP ratio shines. The World Bank maintains data on stock market capitalization as a percentage of GDP for many nations covering several decades. With U.S. stocks near record highs in terms of stock market capitalization as a percentage of GDP in 2019, stocks in most other countries were relatively inexpensive. The primary flaw of relative valuation is that it may condemn investors to making the best of a bad situation. When limited to a single asset class, relative valuation can do little more than reduce losses in extreme circumstances. For example, value funds generally did much better than the S&P 500 during the 2000-2002 bear market.

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