Valuation Methods
Below is an explanation of the main methods used to value a company.
What are the main valuation methods?
When valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These are the most common methods used in in investment banking, equity research, private equity, corporate development, MBOs and most areas of finance.
Method 1: DCF Analysis
In the Discounted Cash Flow (DCF) approach you forecast the business’ unlevered free cash flow into the future and discount it back to today at the firm’s WACC.
A DCF analysis is performed by building a financial model in Excel and requires an extensive amount of detail and analysis. It is the most detailed of the three approaches, requires the most assumptions and often produces the highest value. However, the effort required for preparing a DCF model will also often result in the most accurate valuation. A DCF model allows the analyst to forecast value based on different scenarios, and even perform a sensitivity analysis.
For larger businesses, the DCF value is commonly a sum-of-the-parts analysis, where different business units are modeled individually and added together. To learn more, see our DCF model infographic.
Method 2: Comparable Analysis (“Comps”)
Comparable company analysis (also called “trading multiples” or “peer group analysis” or “equity comps” or “public market multiples”) is a relative valuation method in which you compare the current value of a business to other similar businesses by looking at trading multiples like P/E, EV/EBITDA, or other ratios. Multiples of EBITDA are the most common valuation method.
The “comps” valuation method provides an observable value for the business, based on what companies are currently worth.
Method 3: Precedent Transactions
Precedent transactions analysis is a form of valuation where you compare the company to other businesses that have recently sold or been acquired in that industry. These values include the take-over premium for which they were acquired.
These values represent the en bloc value of a business. They are useful for M&A transactions, but can easily become stale-dated and no longer reflective of the current market.
Football field chart (summary)
Bankers will often put together a football field chart to summarize the range of values for a business based on the different valuation methods used. Below is an example of a football field graph, which is typically included in an investment banking pitch book.
More valuation methods
Another valuation method for a company that is a going concern is called “ability to pay analysis”, This approach looks at the maximum price an acquirer can pay for a business while still hitting some target. For example, if a private equity firm needs to hit a hurdle rate of 30%, what is the maximum price it can pay for the business?
If the company will not continue to operate, than a liquidation value will be estimated based on breaking up and selling the company’s assets,
Finally, non-operating assets may be valued at either book value, or market value.
Additional valuation resources
To learn more about how to value a business, or to prepare for a career in corporate finance, we’ve got all the resources you need! Here are some of our most popular resources relate to valuation methods: