What are the Key Valuation Methods?

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What are the Key Valuation Methods?

CFO Tech Outlook | Friday, August 20, 2021

The comps valuation approach offers an observable value for the company based on what all similar businesses are actually worth. Comps are the most commonly used solution since they are easy to quantify and still up to date.

FREMONT, CA: There are three fundamental valuation approaches used by business experts when analyzing an organization as a matter of concern: DCF analysis, comparable company analysis, and precedent transactions. These are the most common valuation methods used in investment banking, market analysis, private equity, business growth, mergers and acquisitions (M&A), Leveraged Buyouts (LBO), and most finance industries.

Comparable Analysis (Comps)

Comparable company analysis (also referred to as trading multiples/ peer group analysis/ equity comps/ public market multiples) is a relative valuation method in which one compares the current value of a business to other similar companies by looking at multiples such as P/E, EV/EBITDA or other ratios. Multiples of EBITDA are the most common form of valuation.

The comps valuation approach offers an observable value for the company based on what all similar businesses are actually worth. Comps are the most commonly used solution since they are easy to quantify and still up to date. It follows from the logic that if company X trades at a 10-fold P/E ratio and company Y has earnings of 2.50 dollars per share, company Y's shares must be worth 25.00 dollars per share (assuming the companies have similar attributes).

Precedent Transactions

Previous transaction analysis is another relative valuation method where one equates the business in question to other firms that have previously been sold or purchased in the same sector. These transaction values shall contain the sale premium contained in the amount at which they were purchased. Values are the en bloc value of a business. They are useful for M&A transactions but can quickly be stalled and no longer reflective of the current market as time passes. They are less widely used than Comps or multiple stock trading.

DCF Analysis

Discounted Cash Flow (DCF) research is an inherent value strategy where an analyst estimates the firm's unreleased free cash flow in the future and discounts it back to today at the company's Weighted Average Cost of Capital (WACC). The DCF research is carried out by creating a financial model in Excel, which involves a considerable amount of description and analysis. It is the most comprehensive of the three methods, and it needs the most calculations and assumptions. However, the work taken to prepare the DCF model will almost always result in the most precise valuation. The DCF model helps the analyst estimate meaning depending on various conditions and even do a sensitivity analysis.  For larger organizations, the DCF value is typically a sum-of-the-part analysis, where different business units are independently modeled and aggregated.

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