Valuation Methods Overview
| Method | Best For | Key Input | Limitation |
|---|---|---|---|
| Discounted Cash Flow (DCF) | Long-term value investors | Free cash flow projections | Sensitive to assumptions |
| P/E Ratio | Profitable mature companies | Earnings per share | Misses growth companies |
| EV/EBITDA | Cross-company comparison | EBITDA, enterprise value | Misses capex requirements |
| Price/Sales (P/S) | High-growth companies | Revenue per share | Ignores profitability |
| Price/Book (P/B) | Banks and financial firms | Book value per share | Ignores intangibles |
| EV/Gross Profit | SaaS and software | Gross profit, enterprise value | Ignores operating costs |
| PEG Ratio | Growth-at-reasonable-price | P/E + growth rate | Growth estimate uncertainty |
DCF Valuation Formula
- Intrinsic Value = Σ (Free Cash Flow_t / (1 + WACC)^t) + Terminal Value / (1 + WACC)^n
- Terminal Value = Final Year FCF × (1 + g) / (WACC - g) where g = terminal growth rate
- WACC = Weighted Average Cost of Capital (typically 8-12% for US equities)
- Free Cash Flow = Operating Cash Flow - Capital Expenditures
- Rule of thumb: a 1% change in WACC changes valuation by 10-15% for long-duration assets
- Always run bull/base/bear scenarios — point estimates give false precision
P/E Ratio Context Table
| P/E Range | Interpretation | Typical Sector | Caution |
|---|---|---|---|
| < 10x | Deep value or distressed | Energy, industrials, banks | Could be value trap |
| 10-15x | Value territory | Mature consumer staples | Low growth expected |
| 15-20x | Fair value range | S&P 500 historical average ~17x | Market-rate pricing |
| 20-30x | Growth premium | Tech, healthcare, consumer | Needs 10%+ EPS growth |
| 30-50x | High growth premium | AI/cloud software | Needs 20%+ EPS growth |
| 50x+ | Early-stage or speculative | Unprofitable high-growth | FCF conversion critical |