Financial Management · Models for the valuation of shares

Comparing Share Valuation Models and Their Limitations

Updated 11 October 2026 · Fact-checked

Comparing valuation models means judging when each method gives a reliable value. Asset-based methods suit asset-rich firms, P/E suits comparable listed firms, the dividend model suits stable dividend payers, and discounted cash flow suits long-term cash-based valuations. No model is best. Choose by context and state limitations.

Understand Comparing Valuation Models and Their Limitations

A share has no single true value. Each model estimates value from a different starting point: assets, earnings, dividends or cash flows. They give different answers because they use different inputs and assumptions.

Asset-based methods value what the business owns, less what it owes. They are easy to understand and give a floor value, which is useful in a break-up or for asset-rich firms such as property companies. They ignore future earnings power, goodwill and intangibles. Book values may be out of date, so you need replacement or realisable values.

Market-based methods such as the P/E ratio apply a multiple to earnings. They are quick and reflect market sentiment. But the answer depends on choosing a suitable P/E. A listed company's P/E may not suit an unlisted one, which is less liquid, so a discount is often applied. Earnings are also affected by accounting policies and may be a single unrepresentative year.

Dividend and cash flow methods value the future income stream. The dividend valuation model (DVM) suits a minority shareholder who receives only dividends. It is very sensitive to the growth rate g and the cost of equity ke. It fails if the dividend is zero or g is greater than or equal to ke. Discounted cash flow suits a controlling stake and gives a theoretical value, but needs long forecasts and a discount rate, and the terminal value often dominates.

Valuations also differ because of: the purpose, the size of the stake (control or minority), the forecast assumptions, market conditions, the quality of the information and whether the market is efficient. A good answer always links the model to the situation.

Key rules to remember

Net asset value per share: (Total assets − Total liabilities) ÷ Number of shares; Use fair values, not just book values, and be clear about whether intangibles are included.
P/E valuation: Value of equity = Earnings × P/E ratio; Share price = EPS × P/E; Use earnings attributable to ordinary shareholders and a P/E from a comparable company.
Earnings yield: Earnings yield = EPS ÷ Share price = 1 ÷ P/E; Value can be found as Earnings ÷ Earnings yield.
Dividend valuation model with growth: P0 = D0 × (1 + g) ÷ (ke − g); Valid only if ke is greater than g and growth is constant. D0 is the dividend just paid.
Dividend growth rate: g = b × r; b is the proportion of earnings retained and r is the return on new investment. It is an estimate.
Discounted cash flow value: Value = Σ [FCF ÷ (1 + r)^t] + terminal value discounted; Free cash flow to equity is discounted at the cost of equity.

How to solve Comparing Valuation Models and Their Limitations questions

For a compare or discuss question, work from the scenario to the model, never the reverse.

1Read the scenario and note the company type: listed or unlisted, asset-rich or service, growing or stable, dividend payer or not.
2Note the purpose and stake: takeover and control, minority holding, flotation or break-up.
3If numbers are required, calculate each requested value carefully and show the formula.
4For each model, state one strength and one limitation that fit this company, not generic ones.
5Explain why the values differ, using the assumptions behind each input such as g, ke, the P/E chosen and asset valuations.
6Give a reasoned conclusion on the most suitable model, or a range of values, and say what further information you would want.

Quickest way: Model, fit, flaw

When to use it: For a Section C discussion or an objective test question asking which model is most suitable or what limits it.

Name the model in one phrase.
Match it to the scenario: what makes it suitable here.
State its key weakness: the input that is hard to estimate.
Add a comparison: one other model that would give a different answer and why.
Close with a recommendation, such as using a range of values.

Common mistakes in Comparing Valuation Models and Their Limitations

Writing a generic list of pros and cons for each model.
Students memorise textbook lists and do not read the scenario.
Fix: Tie each point to the company's facts, such as unlisted status, low dividends or heavy intangibles.
Using the DVM when g is greater than or equal to ke, or when no dividend is paid.
Students apply the formula without checking its conditions.
Fix: Check ke > g and that dividends are paid. Otherwise say the model is unsuitable and use another.
Using D0 instead of D0 × (1 + g) in the numerator.
Confusing the dividend just paid with next year's dividend.
Fix: Check whether the question gives D0 (just paid) or D1 (next year) and adjust.
Applying a listed company's P/E to an unlisted company without adjustment.
Treating the P/E as a fixed fact.
Fix: Comment on lower marketability, size and risk, and discuss a discount.
Saying asset values ignore nothing, or that book value equals market value.
Treating the balance sheet as a fair value measure.
Fix: State that assets need revaluation and that intangibles and goodwill are often missing.
Concluding that one model is simply best.
Wanting a definitive answer.
Fix: Say which is most suitable for the purpose and recommend considering a range of values.

Worked examples

Example 1

Zeta Co, an unlisted company, has earnings of $600,000 and 1,000,000 shares. A similar listed company has a P/E of 12. Zeta has paid a dividend of $0.20 per share and its cost of equity is 10% with dividend growth of 4%. Calculate the value per share using the P/E method and the DVM, and explain why they differ.

Show the solution

EPS = $600,000 ÷ 1,000,000 = $0.60.
P/E value per share = $0.60 × 12 = $7.20.
DVM: P0 = 0.20 × 1.04 ÷ (0.10 − 0.04) = 0.208 ÷ 0.06 = $3.47 (to two decimals, 3.4667).
The DVM value is lower because it reflects only the dividends a minority holder receives. Zeta pays out a third of earnings (0.20 ÷ 0.60).
The P/E value reflects earnings, which a controller could access, and uses a listed company's multiple, which may be too high for an unlisted firm.
The DVM is also very sensitive: if g were 5%, the value would be 0.20 × 1.05 ÷ 0.05 = $4.20.

Answer: P/E method: $7.20 per share. DVM: about $3.47 per share. The gap arises from the dividend-only focus of the DVM versus the earnings-based, listed-company multiple of the P/E method, and from the sensitivity of each to its inputs.

Example 2

A property investment company has net assets with a book value of $50 million. The directors say its properties have a market value $12 million higher. There are 10 million shares. Its earnings are volatile. Which valuation model is most suitable and what are its limitations?

Show the solution

Adjusted net assets = $50 million + $12 million = $62 million.
Value per share = $62 million ÷ 10 million = $6.20.
Suitability: the company holds tangible assets that can be sold, so an asset-based value gives a sensible floor. Volatile earnings make the P/E method unreliable.
Limitation 1: the $12 million is the directors' estimate, so an independent valuation is needed.
Limitation 2: it ignores future rental growth, goodwill and management quality.
Limitation 3: selling costs and tax on disposal are not deducted, so the realisable value may be lower.
Recommend using the asset value as a base, and cross-checking with a dividend or cash flow value of rental income.

Answer: Adjusted net asset value is $6.20 per share. It is the most suitable model here, but it relies on unverified property values, ignores future income and goodwill and ignores disposal costs, so it should be cross-checked.

Exam tips

In Section C, always give a recommendation. Discussion marks are lost by listing points without a conclusion.
For objective test questions asking about limitations, look for the input the model depends on, such as g in the DVM or the chosen P/E.
Show every formula and the inputs you used so that you earn method marks even if the arithmetic slips.
Use the scenario's words: unlisted, minority stake, intangible assets. Examiners reward application.
Remember that objective test answers are all or nothing, so check the DVM numerator and the ke > g condition before choosing.

Practice questions from Models for the valuation of shares

Comparing Valuation Models and Their Limitations: frequently asked questions

Which valuation model is best in ACCA FM?

No model is always best. Choose by the company and purpose: asset-based for asset-rich or break-up cases, P/E for comparable listed companies, DVM for minority holders of stable dividend payers and DCF for long-term cash-generating projects or controlling stakes.

What are the limitations of the P/E method?

It depends on finding a suitable comparable P/E, and listed company multiples may not fit an unlisted company. Earnings can be distorted by accounting policies or one-off items. It also reflects market sentiment, which may be wrong.

What are the limitations of the dividend valuation model?

It is very sensitive to g and ke and fails if g is greater than or equal to ke or if no dividends are paid. It assumes constant growth and values only the dividend stream, so it suits minority shareholders.

Why do different valuation models give different values?

They use different inputs and assume different things: assets, earnings, dividends or cash flows. Purpose, stake size, forecasts, market conditions and information quality also change the result.