Relative Valuation With Multiples

Multiples-based valuation assumes a stock is worth what similar stocks trade at, adjusted for company-specific factors. The standard multiples include price-to-earnings (P/E), enterprise value to EBITDA (EV/EBITDA), enterprise value to sales (EV/Sales), and price to book value (P/B). Different multiples suit different sectors: EV/EBITDA works for capital-intensive businesses; P/E works for mature businesses; EV/Sales works for high-growth or unprofitable businesses; P/B works for banks and insurers.

The mechanics are straightforward. Identify a peer group. Calculate the relevant multiple for each. Take a median. Apply it to the target's forecast metric. Adjust for company-specific factors: growth, profitability, capital structure, and quality.

The strength of multiples is they reflect current market pricing directly. If the market pays 20 times earnings for the sector, the target should trade around there absent specific reasons for a discount or premium. The weakness is multiples cannot tell you whether the market itself is mispricing the sector.

Intrinsic Valuation With DCF

DCF assumes a stock is worth the cash flows it will generate in the future, discounted to present value. Forecast free cash flow for 5-10 years, calculate a discount rate (WACC), discount each year, estimate a terminal value for the period beyond, and sum to arrive at enterprise value.

DCF's strength is forcing you to think about what actually drives value: revenue growth, margins, capital efficiency, and cost of capital. It anchors valuation to fundamentals rather than to market pricing. Its weakness is that DCF outputs are extremely sensitive to terminal growth and discount rate, both difficult to pin down precisely.

When to Use Each Method

Use multiples when comparable companies genuinely exist, when the market is functioning normally, and when the target has established operating patterns. Multiples are less useful for early-stage businesses, unique franchises without genuine peers, or during market dislocations.

Use DCF when future cash flows are relatively predictable, when the business has long operating history, and when the analytical goal is understanding what price the fundamentals justify. DCF is less useful for young businesses with uncertain paths to profitability or businesses where terminal value dominates the output.