Discounted Cash Flow (DCF): The Intrinsic Approach
The DCF model is based on a simple but powerful idea: a company’s value today is the sum of all the cash it will generate in the future, adjusted for risk and time.
To build a DCF, analysts first forecast the company’s free cash flow (FCF), which represents the money left over after operating expenses and necessary investments. These projections typically cover the next five to ten years, incorporating assumptions about revenue growth, profit margins and capital requirements.
Because money today is worth more than money in the future, each year’s cash flow is discounted back to its present value using a rate that reflects the risk of the business (often the company’s weighted average cost of capital, or WACC).
Beyond the forecast period, analysts estimate a terminal value, representing the business’s ongoing worth. This can be calculated by assuming cash flows grow at a steady, modest rate indefinitely (the perpetuity growth method) or by applying a multiple to the final year’s earnings (the exit multiple method).
The DCF is widely used for private companies, startups and situations where market based comparisons aren’t available. However, its accuracy depends heavily on the assumptions. Overly optimistic projections can lead to inflated valuations.
Comparable Company Analysis (Comps): The Market Benchmark
Rather than projecting future cash flows, Comparable Company Analysis (Comps) values a business by comparing it to similar publicly traded companies. The logic is straightforward: if a peer group trades at an average of 10 times earnings, a company with similar characteristics should be valued similarly.
To perform a comps analysis, analysts first select a group of comparable firms ideally those in the same industry, with similar growth rates, profitability and risk profiles. They then examine valuation multiples, such as:
- Price to Earnings (P/E): Compares share price to net income
- Enterprise Value to EBITDA (EV/EBITDA): Measures total company value relative to earnings before interest, taxes, depreciation and amortisation
- Price to Sales (P/S): Useful for companies not yet profitable
These multiples are averaged or adjusted for differences (for example, higher growth may justify a higher multiple), then applied to the target company’s financials to estimate its value.
Comps are quick and intuitive, making them a favourite for valuing public companies or checking the reasonableness of a DCF. However, they rely on market sentiment. If the entire sector is overvalued, comps will reflect that bias.
Precedent Transactions: Learning from Past Deals
While comps look at stock market valuations, Precedent Transactions focus on what buyers have actually paid to acquire similar companies in past M&A deals. This method is especially useful in investment banking, where the goal is often to determine a fair acquisition price.
The process involves researching recent deals in the same industry, noting the valuation multiples paid (for example, EV/EBITDA, P/E). Because buyers typically pay a control premium (an extra amount for the power to make strategic decisions), precedent transactions usually yield higher valuations than comps.
For instance, if a software company was acquired for 12 times EBITDA, and another similar business is now being evaluated, that multiple serves as a benchmark. Adjustments may be made for differences in size, growth or market conditions.
This method is particularly relevant for M&A, private equity and corporate development, as it reflects real world deal dynamics rather than just trading multiples. However, finding truly comparable transactions can be challenging, especially in niche industries.
Which Method Should Be Used?
In practice, no single valuation method is perfect. Each has strengths and weaknesses:
- DCF is theoretically sound but sensitive to assumptions
- Comps are market driven but can be skewed by temporary trends
- Precedent Transactions reflect real acquisitions but may lack perfect comparables
Sophisticated analysts use all three, triangulating a valuation range rather than relying on one number. By cross checking different approaches, they can identify inconsistencies and arrive at a more defensible estimate.
Ultimately, valuation is as much an art as a science. The numbers provide a framework, but judgement and experience determine where, within that range, the true value lies.
IB Insights 
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