The four core methods
Corporate-finance work most often uses public comparable companies, precedent transactions, DCF, and LBO or ability-to-pay analysis. The methods answer different questions and rely on different evidence.
Public comparable companies
Public comps ask how the market values companies with similar economics. The method is most useful when a credible set of publicly traded peers exists and the analyst can normalize differences in growth, margin, capital intensity, business mix, geography, and accounting. It reflects current market pricing and minority ownership.
Precedent transactions
Precedents ask what buyers paid in comparable control transactions. The method incorporates transaction evidence but can be distorted by market cycle, synergies, buyer motivation, auction pressure, financing conditions, and incomplete public data. A transaction is comparable only when its structure and economics are understood.
Discounted cash flow
DCF asks what forecast cash flows are worth today. It is conceptually direct and useful when the business can be forecast with a defensible operating model. It is sensitive to assumptions, particularly terminal value and discount rate, and can produce false precision when the forecast is weak.
LBO or ability-to-pay
LBO analysis asks what a financial sponsor can pay while using a feasible capital structure and achieving a required return. The result depends on debt capacity, interest rates, cash conversion, exit value, and return requirements. It can help establish a financial-buyer reference point but shouldn't be called a universal floor.
Method selection by situation
| Situation | Commonly useful methods | Important limitation |
|---|---|---|
| Public-company trading view | Public comps, DCF, sum of the parts | Market price may reflect factors or sentiment not captured by fundamentals |
| Sale of a company | Public comps, precedents, DCF, LBO, buyer-specific analysis | Control, synergies, tax, financing, and process matter |
| IPO | Public comps, DCF, investor feedback, dilution and float analysis | Pricing is affected by offering size, market demand, and allocation |
| Bank or insurer | Equity-based multiples, dividend or excess-return methods, book value | Enterprise-value methods can be difficult because debt is part of operations |
| Early-stage or pre-profit company | Revenue or unit metrics, scenario DCF, venture methods | Wide uncertainty and dilution dominate |
| Commodity or resource business | NAV, reserve or production metrics, cycle-adjusted cash flow | Commodity price and resource assumptions can dominate |
| Distressed company | Recovery, liquidation, reorganization value, DCF, precedents | Legal priority, liquidity, and timing are central |
Enterprise-value and equity-value metrics
Use enterprise-value multiples with operating metrics available to all capital providers, such as revenue, EBITDA, or EBIT. Use equity-value multiples with metrics attributable to common equity, such as net income, EPS, or book value. Mixing the numerator and denominator creates a conceptual error even if the spreadsheet formula works.
Advantages and disadvantages
Public comps are fast and observable but can compare unlike businesses and inherit market mispricing. Precedents reflect paid prices but can be stale and transaction-specific. DCF is tailored to the company but sensitive to forecasts. LBO analysis incorporates financing reality but changes with credit conditions and sponsor assumptions.
Triangulation without averaging
A valuation range should show the methods side by side, the metric or assumptions used, and the reason one method deserves more weight. A mature predictable utility may receive more DCF weight than an early-stage company. A control sale may use precedents more heavily. A sponsor auction may use the LBO as an important affordability reference.
Sum-of-the-parts valuation
When a company contains businesses with different economics, value each segment with an appropriate method and add nonoperating assets, subtract central costs and claims, and account for tax leakage or structural discounts. The SOTP isn't automatically more accurate; it can multiply assumptions and ignore interdependence among segments.
Current improvements over older course material
Avoid claims that DCF is always the “most accurate,” that precedents automatically equal control value, or that an LBO always establishes a floor. Each statement depends on data quality, structure, and market conditions. The correct method is the one that answers the decision with the least misleading assumptions.