A banker hands you a page with a target's value pinned to the nearest million. It looks like an answer. It is closer to an opinion wearing a suit, the output of assumptions you can't see, dressed up to look like arithmetic. Learn to read the three methods underneath that page and you stop being a passenger in your own deals.

The quick version

  • Discounted cash flow (DCF) asks what the business is worth on its own merits, its future cash, discounted back to today. It's the most honest method and the easiest to fool yourself with.
  • Comparable companies ("comps") asks what the market pays for similar businesses right now. Fast and grounded, but it inherits whatever mood the market is in.
  • Precedent transactions asks what acquirers have actually paid for similar companies. It's the only method that includes the control premium, the extra you pay to own and run the thing.
  • Treat the three as a triangulation, not a vote. Where they disagree is where the real questions live.

The idea in depth

Every method answers the same question, "what is this worth?", and they disagree on purpose, because they measure different things. The toolkit splits in two. Intrinsic valuation values a business by its own cash flows. Relative valuation values it by what the market pays for comparable assets. Aswath Damodaran of NYU Stern, whose free online course is the closest thing the field has to a standard reference, frames the discipline around that split, and warns that the precision of the output is an illusion bought with the vagueness of the inputs.

Discounted cash flow: value from first principles

DCF is the purest expression of one idea: a business is worth the cash it will hand its owners in future, with future cash worth less than cash today. You forecast free cash flow for several years, estimate a "terminal value" for everything after that, and discount the whole stream back at the company's cost of capital (its WACC). McKinsey's Valuation: Measuring and Managing the Value of Companies (Koller, Goedhart and Wessels) builds its entire framework on this: value comes from return on invested capital and growth, and "anything that doesn't increase cash flow doesn't create value."

The honesty is the point. DCF forces you to state, out loud, what you believe about growth, margins, reinvestment and risk. So when you read a DCF, ignore the headline and go straight to two inputs, the terminal-value assumption and the discount rate. In most models the majority of the value sits past year five, in the terminal value, so a small nudge to the long-run growth rate or the discount rate swings the answer wildly.

The honest limitation: that same sensitivity makes DCF easy to reverse-engineer. Decide the answer you want, then tune the growth rate until the model agrees. Damodaran's standing warning is that a valuation is only as unbiased as the person building it, putting a number on a judgement call doesn't launder the judgement out of it.

Comps and precedents: value by comparison

Relative valuation skips the forecasting and asks a blunter question: what is the market already paying for businesses like this? You pick a peer set, compute a multiple, enterprise value to EBITDA, price to earnings, EV to revenue, and apply it to your target's numbers. Comparable companies use the multiples of similar listed businesses trading today. Precedent transactions use the multiples paid in past acquisitions of similar businesses.

The gap between those two is the most useful thing in the whole toolkit. Precedent multiples are almost always higher, because an acquirer buying the whole company pays a control premium, extra money for the right to run the business, change its strategy and capture synergies. Comps price a minority share you can sell tomorrow; precedents price the keys to the building. Use comps to anchor "what it's worth as is," use precedents to anchor "what someone might pay to own it," and read the gap between them as a rough measure of the premium, and the synergies, you'd have to justify.

The honest limitation: a multiple is a shortcut, not an escape from analysis. If your peers trade at 8x EBITDA and you don't know why, you're borrowing the market's reasoning without checking it. Comps inherit bubbles and panics wholesale; precedents can be stale, drawn from a different rate environment or a frothier deal market, and reported figures often hide the messy structure (earn-outs, assumed debt) behind a clean-looking number.

flowchart TD
    Q(["What is this business worth?"])
    Q --> INT(["Intrinsic: value its own cash"])
    Q --> REL(["Relative: value vs. the market"])
    INT --> DCF(["DCF, forecast cash, discount at WACC"])
    REL --> COMP(["Comps, multiples of listed peers"])
    REL --> PREC(["Precedents, multiples paid in past deals"])
    DCF --> TRI(["Triangulate the range"])
    COMP --> TRI
    PREC --> TRI
The three workhorse methods split into intrinsic and relative, then converge on a range rather than a point. Leaders Loop

Why no single number wins

Mature dealmakers run all three because each method is blind in a way the others aren't. DCF sees fundamentals but not the market's mood; comps see the market but not the premium; precedents see the premium but may be looking at yesterday's market. Run together, they produce a range, the "football field" chart bankers draw, one bar per method. The number you act on is a judgement about where in that range the truth sits, not the average of the bars.

This matters because the cost of getting it wrong is brutally well documented. KPMG analysed more than 3,000 public-to-public deals over $100m between 2012 and 2022 and found that 57% of acquirers destroyed shareholder value, and the two leading causes were overestimating the benefits (overpaying) and failing to operationalise the gains (integration) (KPMG, The M&A Dance, 2025). Valuation discipline is the first line of defence against the first of those causes. The habit worth building: anchor your walk-away price to the intrinsic (DCF) view, and treat any premium above it as a synergy bet you must be able to name, size and deliver, not a number you backfilled to win the auction.

A worked example

Illustrative figures, invented to show the mechanics, not a real company.

Suppose you're weighing an acquisition of "Northwind Logistics," a private freight-software firm with EBITDA of £10m.

  • DCF. You forecast five years of free cash flow, assume 2.5% long-run growth after that, and discount at a 10% WACC. The model returns an enterprise value of about £95m, your view of the business standing alone.
  • Comps. Three listed freight-software peers trade at a median 8x EV/EBITDA. Applied to Northwind's £10m, that's £80m. The market, today, would price it lower than your fundamentals suggest, worth asking why.
  • Precedents. Two recent acquisitions in the space closed at 11x EBITDA, premiums included. That implies £110m, what buyers have paid to own firms like this.

Your football field runs roughly £80m–£110m, with your own DCF at £95m in the middle. The £110m precedent figure embeds a ~£30m premium over the comps view. To pay anywhere near it, you need synergies you can name, say, cross-selling to your existing customers and shutting a duplicate data centre, worth more than £30m after tax, integration cost and risk. If you can't write that sentence with a straight face, your number is the comps anchor, not the precedent one. That single test separates a priced bid from a hopeful one.

flowchart LR
    C(["Comps · £80m
value as is"]) --> R(["Your range
£80m–£110m"])
    D(["DCF · £95m
standalone worth"]) --> R
    P(["Precedents · £110m
price to own it"]) --> R
    R --> J(["Judgement: where does truth sit?
Premium = a synergy bet you must justify"])
The illustrative Northwind range. The methods bracket the answer; the decision is which end you can defend. Leaders Loop

Frequently asked questions

Which valuation method is the "right" one?

None on its own. DCF is the most theoretically complete because it values the business by its own cash, but it's the most sensitive to assumptions. Comps and precedents ground you in real market prices but inherit the market's biases. Professionals run all three and reason about the range. If you're forced to lead with one, lead with DCF for your walk-away price and use the others to sanity-check it.

Why are precedent-transaction values usually higher than comps?

Because precedents include a control premium. A comp is the price of a small, tradeable slice of a company; a precedent is the price someone paid to acquire the whole thing and control it. Buyers pay extra for control, to set strategy and capture synergies, so deal multiples typically sit above trading multiples for otherwise similar businesses.

What is terminal value, and why does it dominate a DCF?

Terminal value is the estimate of all cash flows beyond your explicit forecast window (often five to ten years), captured as a single figure. Because a healthy business generates cash for decades, that one number frequently accounts for the majority of the total DCF value. That's exactly why small changes to its inputs, the long-run growth rate, the discount rate, swing the answer so much, and why it's the first thing to stress-test.

Does valuation even matter if most deals overpay anyway?

It matters more because of that. KPMG's data showing that most acquirers destroy value traces a large share of the damage to overpayment. Valuation discipline, knowing your intrinsic anchor and refusing to pay above it without nameable synergies, is precisely the habit that keeps you out of that majority. The method doesn't fail; the discipline to obey it does.

How does this connect to cost of capital?

Directly. The discount rate in a DCF is the cost of capital (WACC), and it's the single input that most quietly determines the answer. A business isn't "worth £95m" in the abstract, it's worth that at a 10% discount rate. Change your view of risk and you change the value, no cash-flow forecast required. That's why cost of capital & WACC is the companion piece to this one.

Related in the Toolkit

Where to go next