Valuation Methods

What are the Main Valuation Methods?

When valuing a company as a going concern there are three main valuation methods used by industry practitioners: (1) DCF analysis, (2) comparable company analysis, and (3) precedent transactions.  These are the most common methods of valuation used in investment bankingInvestment BankingInvestment banking is the division of a bank or financial institution that serves governments, corporations and institutions by providing underwriting (capital raising) and mergers and acquisitions (M&A) advisory services. Investment banks act as intermediaries between investors and corporations who require capital, equity research, private equity, corporate development, mergers & acquisitions (M&AMergers Acquisitions M&A ProcessThis guide takes you through all the steps in the M&A process. Learn how mergers and acquisitions and deals are completed. In this guide, we'll outline the acquisition process from start to finish, the various types of acquirers (strategic vs. financial buys), the importance of synergies, and transaction costs), leveraged buyouts (LBOLeveraged Buyout (LBO)A leveraged buyout (LBO) is a transaction where a business is acquired using debt as the main source of consideration. An LBO transaction typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70-80% of the purchase price) to achieve an internal rate return IRR >20%) and most areas of finance.

 

Image: CFI’s Business Valuation Course.

 

As shown in the diagram above, when valuing a business or asset, there are three broad categories that each contain their own methods. The Cost Approach looks at what it cost to build something and this method is not frequently used by finance professionals to value a company as a going concern. Next is the Market Approach, this is a form of relative valuation and frequently used in industry. It includes Comparable Analysis Precedent Transactions.  Finally, the discounted cash flow (DCF) approach is a form of intrinsic valuation and is the most detailed and thorough approach to valuation modeling.

 

Method 1: Comparable Analysis (“Comps”)

Comparable company analysisComparable Company AnalysisHow to perform Comparable Company Analysis. This guide shows you step-by-step how to build comparable company analysis ("Comps"), includes a free template and many examples. Comps is a relative valuation methodology that looks at ratios of similar public companies and uses them to derive the value of another business (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/EBITDAEBITDA MultipleThe EBITDA multiple is a financial ratio that compares a company's Enterprise Value to its annual EBITDA.  This multiple is used to determine the value of a company and compare it to the value of other, similar businesses. A company's EBITDA multiple provides a normalized ratio for differences in capital structure,, or other ratios. Multiples of EBITDAEBITDAEBITDA or Earnings Before Interest, Tax, Depreciation, Amortization is a company's profits before any of these net deductions are made. EBITDA focuses on the operating decisions of a business because it looks at the business’ profitability from core operations before the impact of capital structure. Formula, examples are the most common valuation method.

The “comps” valuation method provides an observable value for the business, based on what companies are currently worth. Comps are the most widely used approach, as they are easy to calculate and always current. The logic follows that, if company X trades at a 10-times P/E ratio, and company Y  has earnings of $2.50 per share, company Y’s stock must be worth $25.00 per share (assuming its perfectly comparable).

[tooltip url="https://corporatefinanceinstitute.com/resources/knowledge/valuation/comparable-company-analysis/"]<img class="wp-image-9638" src="https://cdn.corporatefinanceinstitute.com/assets/comparable-company-valuation-1024x361.png" alt="comparable company analysis" width="1089" height="384" srcset="https://cdn.corporatefinanceinstitute.com/assets/comparable-company-valuation-1024x361.png 1024w, /assets/comparable-company-valuation-300x106.png 300w, /assets/comparable-company-valuation-768x271.png 768w, /assets/comparable-company-valuation-1200x423.png 1200w, /assets/comparable-company-valuation-600x212.png 600w, /assets/comparable-company-valuation-24x8.png 24w, /assets/comparable-company-valuation-36x13.png 36w, /assets/comparable-company-valuation-48x17.png 48w, /assets/comparable-company-valuation.png 1409w" sizes="(max-width: 1089px) 100vw, 1089px">[/tooltip] Example Comps Table

 

Method 2: Precedent Transactions

Precedent transactions analysisPrecedent Transaction AnalysisPrecedent transaction analysis is a method of company valuation where past M&A transactions are used to value a comparable business today. Commonly referred to as “precedents”, this method of valuation is used to value an entire business as part of a merger/acquisition commonly prepared by analysts is another form of relative valuation where you compare the company in question to other businesses that have recently been sold or acquired in the same industry. These transaction values include the take-over premium included in the price 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 as time passes. They are less commonly used than Comps or market trading multiples.

[tooltip url="https://corporatefinanceinstitute.com/resources/knowledge/valuation/precedent-transaction-analysis/"]<img class="wp-image-9642 size-large" src="https://cdn.corporatefinanceinstitute.com/assets/precedent-transactions-valuation-1024x361.png" alt="Precedent transaction analysis example" width="1024" height="361" srcset="https://cdn.corporatefinanceinstitute.com/assets/precedent-transactions-valuation-1024x361.png 1024w, /assets/precedent-transactions-valuation-300x106.png 300w, /assets/precedent-transactions-valuation-768x271.png 768w, /assets/precedent-transactions-valuation-1200x423.png 1200w, /assets/precedent-transactions-valuation-600x212.png 600w, /assets/precedent-transactions-valuation-24x8.png 24w, /assets/precedent-transactions-valuation-36x13.png 36w, /assets/precedent-transactions-valuation-48x17.png 48w, /assets/precedent-transactions-valuation.png 1406w" sizes="(max-width: 1024px) 100vw, 1024px">[/tooltip] Example Transaction Analysis

 

Method 3: DCF Analysis

Discounted Cash Flow (DCF)DCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business.  DCF stands for Discounted Cash Flow, so the model is simply a forecast of a company’s unlevered free cash flow discounted back to today’s value.  This free DCF model training guide will teach you the basics, step by step with examples and images analysis is an intrinsic valueIntrinsic ValueThe intrinsic value of a business (or any investment security) is the present value of all expected future cash flows, discounted at the appropriate discount rate. Unlike relative forms of valuation that look at comparable companies, intrinsic valuation looks only at the inherent value of a business on its own. approach where an analyst forecasts the business’ unlevered free cash flowCash FlowCash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual has. In finance, the term is used to describe the amount of cash (currency) that is generated or consumed in a given time period. There are many types of Cash Flows and important uses for it in running a business into the future and discount it back to today at the firm’s Weighted Average Cost of Captial (WACCWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula  is = (E/V x Re) + ((D/V x Rd)  x  (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator).

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 CFI’s DCF model infographicDCF Analysis InfographicHow discounted cash flow (DCF) really work. This DCF analysis infographic walks through the various steps involved in building a DCF model in Excel..

 

[tooltip url="https://courses.corporatefinanceinstitute.com/courses/business-valuation-fundamentals-certificate-course"]<img class="wp-image-9646 size-large" src="https://cdn.corporatefinanceinstitute.com/assets/dcf-model-valuation-1024x660.png" alt="DCF model valuation approach" width="1024" height="660" srcset="https://cdn.corporatefinanceinstitute.com/assets/dcf-model-valuation-1024x660.png 1024w, /assets/dcf-model-valuation-300x193.png 300w, /assets/dcf-model-valuation-768x495.png 768w, /assets/dcf-model-valuation-600x386.png 600w, /assets/dcf-model-valuation-466x300.png 466w, /assets/dcf-model-valuation-24x15.png 24w, /assets/dcf-model-valuation-36x23.png 36w, /assets/dcf-model-valuation-48x31.png 48w, /assets/dcf-model-valuation.png 1096w" sizes="(max-width: 1024px) 100vw, 1024px">[/tooltip] DCF Valuation Model

Image: CFI’s Business Valuation Course.

 

Football Field Chart (summary)

Investment bankers will often put together a football field chartFootball Field Chart TemplateA football field chart is used to display a range of values for a business. Download our free Excel football field chart template and learn how to make one in Excel. The reason they're used is to visually show what the range of values for a business are and see where, an average, a target valuation lies compared to 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 bookInvestment Banking Pitch BookHow to make an investment banking pitch book. This guide will teach you what's included, how to make an IB pitch book, and provides examples of slides.

As you can see, the graph summarizes the company’s 52-week trading range (it’s stock price, assuming it’s public), the range of prices analysts have for the stock, the range of values from comparable valuation modeling, the range from precedent transaction analysis, and finally the DCF valuation method. The orange dotted line in the middle represents the average valuation from all the methods.

 

Football Field Chart TemplateA football field chart is used to display a range of values for a business. Download our free Excel football field chart template and learn how to make one in Excel. The reason they're used is to visually show what the range of values for a business are and see where, an average, a target valuation lies compared to

 

Image: Free Football Field ChartFootball Field Chart TemplateThis football field chart template can be used to summarize a range of values for a business, based on different valuation methods. The purpose of the football field chart is to show how much someone might be willing to pay for a business, whether acquiring all of it, part of it, or even a single share (depending on th.

 

More Valuation Methods (Video)

The cost approach, which is not as commonly used in corporate finance, looks at what it actually cost or would cost to re-build the business. This approach ignores any value creation or cash flow generation and only look at things through the lens of “cost = value”.

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 equityPrivate Equity Career ProfilePrivate equity analysts & associates perform similar work as in investment banking. The job includes financial modeling, valuation, long hours & high pay firm needs to hit a hurdle rateHurdle Rate DefinitionA hurdle rate is the rate of return that must be achieved before accepting and funding an investment project. Hurdle rates are used in financial modeling to calculate NPV. If IRR > Hurdle Rate then the investment creates value. The rate is determined by assessing the cost of capital, risks involved, opportunity cost of 30%, what is the maximum price it can pay for the business?

If the company will not continue to operate, then a liquidation value will be estimated based on breaking up and selling the company’s assets. This value is usually very discounted as it assumes the assets will be sold as quickly as possible to any buyer.

 

 

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:

• Valuation infographicValuation InfographicOver the years we've spent a lot of time thinking about and working on business valuation across a broad range of transactions. This valuation infographic – how to value a  business
• Terminal valueDCF Terminal Value FormulaTerminal value formula is used to calculate the value a business beyond the forecast period in DCF analysis. It's a major part of a financial model as it makes up a large percentage of the total value of a business. There are two approaches to calculate terminal value: (1) perpetual growth, and (2) exit multiple
• Weighted Average Cost of CapitalWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula  is = (E/V x Re) + ((D/V x Rd)  x  (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator
• How to get a job in investment bankingHow to get a job in investment bankingThis guide will outline how to get a job in investment banking using out top three tactics: networking and resume, interview prep, and technical skills
• Excel formulas for financeExcel Formulas Cheat SheetCFI's Excel formulas cheat sheet will give you all the most important formulas to perform financial analysis and modeling in Excel spreadsheets.