The role of profitability capabilities in company valuation is a topic that has been widely discussed and researched in the field of finance and business. This literature review aims to provide an overview of existing research on this subject.
Profitability and Company Valuation: Numerous studies have established a positive relationship between profitability measures, such as return on assets (ROA) or return on equity (ROE), and company valuation. Higher profitability indicates better financial performance, which typically leads to higher company valuations.
Profitability Drivers: Researchers have identified various factors that influence a company’s profitability capabilities, including industry dynamics, competitive advantage, operational efficiency, innovation, cost management, pricing power, and marketing strategies. Understanding these drivers can help firms enhance their profitability and subsequently improve their valuation.
Financial Performance Metrics: In addition to traditional accounting-based metrics like ROA and ROE, researchers have explored alternative measures of profitability such as economic value added (EVA) and cash flow-based metrics. These metrics provide a different perspective on profitability capabilities by considering factors like cost of capital or cash generation capacity.
Firm-specific Factors: Studies have examined how firm-specific characteristics impact the relationship between profitability capabilities and valuation. Factors such as firm size, growth opportunities, leverage levels, ownership structure, corporate governance practices, and risk profiles can all influence the valuation implications of a firm’s profitability.
Industry Context: The role of profitability capabilities in company valuation may vary across industries due to industry-specific characteristics. Researchers have investigated how industry competitiveness, barriers to entry, market concentration, technological advancements, regulatory environment, and other industry factors affect the relationship between profitability and valuation.
International Perspectives: The literature also explores cross-country variations in the role of profitability capabilities in company valuation. Differences in accounting standards, cultural norms, institutional frameworks, and market conditions can impact how investors perceive and value companies’ profitability performance across different countries.
Overall, this literature review highlights the significance of profitability capabilities in company valuation. It emphasizes the positive relationship between profitability and valuation, explores various profitability drivers, considers alternative performance metrics, examines firm-specific factors and industry contexts, and provides insights into international perspectives on this topic.
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