We've mastered market multiples and comparable analysis. Now let's explore the most theoretically rigorous valuation method: Discounted Cash Flow analysis, or DCF.

While multiples tell us what markets currently pay, DCF calculates what a business is fundamentally worth based on the cash it will generate.

Engagement Message

If you had to choose one valuation method for true worth, which feels more dependable: market multiples or discounted future cash flows?

DCF works on a simple principle: a business is worth the total cash it will generate for owners over its lifetime.

But there's a catch - future cash is worth less than cash today. A dollar you receive in five years isn't as valuable as a dollar in your pocket right now.

Engagement Message

Would you prefer $100 today or the same $100 five years from now—and why?

This concept is called the time value of money. Money today can be invested to earn returns, making it more valuable than the same amount received later.

If you can earn 10% annually, $100 today becomes $161 in five years. So $100 received five years from now is only worth about $62 in today's dollars.

Engagement Message

Name one reason why $100 received today is worth more than $100 five years down the road.

DCF accounts for this by "discounting" future cash flows back to present value using an appropriate rate of return.

This discounting process converts all future cash flows into today's dollar terms, allowing us to sum them up for a total business value.

Engagement Message

In one sentence, why is discounting future cash flows considered more fundamental than relying on market multiples?

Here's the key difference: multiples show what markets pay (relative value), while DCF calculates what a business should be worth (intrinsic value).

Market multiples can be influenced by investor sentiment, bubbles, or temporary market conditions. DCF focuses purely on business fundamentals.

Engagement Message

During a market crash, which valuation method is likelier to give a steadier estimate—multiples or DCF?

The DCF framework has three main components: projecting future cash flows, determining the right discount rate, and calculating terminal value.

We'll master each component in upcoming units, building your DCF skills step by step.

Engagement Message

Of cash-flow projections, discount rate, and terminal value, which do you think is hardest to estimate accurately?

DCF requires more work than multiples but provides deeper insights. You're building the business value from scratch rather than relying on what others think.

Professional investors often use DCF as their primary method, especially for long-term investments where market sentiment matters less than business fundamentals.

Engagement Message

Give an example of when a DCF would provide better insight than using market multiples.

Type

Swipe Left or Right

Practice Question

Let's test your understanding of DCF versus market multiples. Swipe each characteristic left for DCF or right for Market Multiples.

Labels

• Left Label: DCF Method
• Right Label: Market Multiples

Left Label Items

• Calculates intrinsic business value
• Requires detailed cash flow projections
• Less influenced by market sentiment
• Takes more time to complete

Right Label Items

• Shows what markets currently pay
• Quick to calculate and compare
• Reflects current investor sentiment
• Based on trading multiples of peers