[aaavl2821]

The DCF is an alluring but dangerous way to value a company. It is alluring because it seems like a much more logical, first-principles way of valuing a company compared to slapping a market-based revenue multiple on a company's projected sales. It is alluring because it is precise.

It is dangerous because it is not accurate. DCFs are very sensitive to assumptions, and confidence intervals for most assumptions are very wide. Two DCF models with credible, but different assumptions can yield hugely different valuations.

DCFs are also dangerous because stocks are not valued solely based on fundamental cash flows. In startups especially, if you do a typical DCF with conservative assumptions, you will miss outlier returns when an acquirer's thesis hinges upon very aggressive assumptions or synergies that a DCF wouldn't capture. This happens all the time in biotech.

It is not true that DCFs are independent of how the market values things. Many key inputs into the DCF, especially the discount rate and terminal value, are calculated in part based on how the market values things.

In practice, investment bankers and investors use several different methodologies, all somewhat flawed, to triangulate around a valuation. Often the DCF yields the highest valuation of these methodologies.

[pstrazzulla]

You're very spot on! DCFs are just one more way to triangulate. However, I think they can be very telling around where value drivers are, what what assumptions have to be in order to get to certain outcomes. It's definitely more useful than "SaaS companies trade at 7x forward revenues" as a DCF can help you capture the idiosyncrasies of your investment.

[aaavl2821]

I agree that DCFs are valuable in driving into assumptions. Taking a few "market" DCFs and seeing for which assumptions your view diverges from market is very helpful

[lifeisstillgood]

Can you list those other methodologies used to value a company?

[aaavl2821]

Most of them are based on "comps", a set of comparable companies to the company you're valuing. You then look at financial valuation ratios for those comps, and apply them to the company you're valuing. Commonly, people look at:

* P/E (trailing or forward earnings)

* Enterprise value / EBITDA (trailing or forward)

* Enterprise value / revenue (trailing or forward)

If comparable companies trade at 15x next-twelve months earnings, and the company you're valuing is expected to earn $10M in the next year, you value the company at equity value of $150M.

Enterprise value = total debt of a company + total market value of equity - cash

EBITDA is Earnings before Interest, Taxes Depreciation and Amortization and is a proxy for a business' operating cash flow (as opposed to profits, which are not always the same as cash flows).

[clairity]

comps on ratios at best gives you first-order approximations of valuation, and the assumptions underlying the comp is both fixed snd hidden. DCF is more explicit about its assumptions and you can change as well as bound those assumptions with new information.

sure, it’s more unsettling to have a range than a single number but a range is as close to reality as we’re likely to get with any valuation (unless it’s a well-established company in a stable industry, where DCF can provide a tight answer).