Relative valuation is a more simple approach and can be easier. Relative valuation estimates the value of an asset by comparing the pricing of similar assets relative to a common variable like earnings, cash flows, book value, or sales. This can be a more convenient analysis and is often used as a reference point. [ETF Liquidity is More Than Trading Volume]
The analysis is called relative because the study is of one stock or ETF against another to find the relative worth and performance of companies in comparison to others, reports Investopedia. While this method is quick and easy, it can be misleading and inaccurate.
The fundamental problems of a company such as historical valuations or the business plan are left out of the comparison, but are important to the overall health of the company or ETF.
After reviewing both methods of evaluating ETFs, it is easy to see why both should be used when finding valuations. Both analysis bring relevant points to the forefront and can help avoid a foolish decision.
Tisha Guerrero contributed to this article.