Market valuation : Observed differences in valuation between small and large cap stocks, when Dividend Discount Model and Free Cash Flow to Equity is applied in the Swedish stock market.

Abstract: Purpose:This thesis is examining two of the most common valuation methods put into practice on firms of different sizes in order to see if the market capitalization has any impact on said valuations. Relevance: Despite the widespread use of the intrinsic valuation methods both in academia and the professional world the amount of coverage concerning real life usage and analysis seems to be somewhat lacking. The numerous studies that cover the pros and cons of different valuation models and their supposed accuracy towards current stock prices. The studies rarely try to analyze whether or not the invisible hand of the market treats the firms differently depending on the market capitalization. Method: In this thesis the Free Cash Flow to Equity and Dividend Discount Model have been applied to 10 different firms of different sizes. The 10 firms were from a market capitalization perspective viewed as  5 “large”  and 5 “small”. For comparison matter, for each of the “large”  firms there was one corresponding “small” firm that operates in a similar line of business. The future growth projections were based on historical data and for the discount rate the Capital Asset Pricing Model (CAPM) was used. Conclusion: The two valuation models showed remarkably similar results, even when applied to firms of greatly different market capitalizations. Within the constraints and delimitations of this thesis, the conclusion is that according to Free Cash Flow to Equity model and Dividend Discount Model models the market does not value the firms differently with regards to market capitalization. In fact the divergencies in terms of absolute numbers of the valuations as a whole only show a 1% percentage unit difference in the Dividend Discount Model and a 2% percentage unit of difference in the Free Cash Flow to Equity model between the large and small cap segments.