Valuation Methods: DCF, Multiples, Sum-of-the-Parts

The Complete Valuation Toolkit

Professional investors use multiple valuation methods and triangulate to a range

Intrinsic Value = PV (Free Cash Flows Years 1-10) + PV (Terminal Value)

Step 1: Project Free Cash Flows (FCF)

FCF = Operating Cash Flow - Capital Expenditures

• Forecast revenue growth (next 5-10 years)
• Estimate margins (EBITDA margin, operating margin)
• Subtract taxes, working capital changes, capex
• Result: Cash available to shareholders

Step 2: Choose Discount Rate (WACC or Required Return)

WACC = (E/V × Cost of Equity) + (D/V × Cost of Debt × (1 - Tax Rate))

• Cost of equity: Risk-free rate + Beta × Equity risk premium (typically 10-12%)
• Cost of debt: Interest rate on borrowings (typically 4-6%)
• Or use simplified required return: 10-15% depending on business risk

Step 3: Calculate Terminal Value (Year 10+)

Terminal Value = FCF_{final year} × (1 + g) / (WACC - g)

• g = perpetual growth rate (typically 2-4%, GDP growth proxy)
• Or use exit multiple: Terminal Value = Final Year EBITDA × 10-15x

Step 4: Discount Everything to Present Value

PV = FCF_{year n} / (1 + WACC)ⁿ

Step 5: Calculate Intrinsic Value Per Share

Intrinsic Value per Share = (Sum of PV + Terminal Value - Net Debt) / Shares Outstanding

Company Profile: "CloudCo" (Hypothetical SaaS Company)

• Current revenue: $1,000M
• EBITDA margin: 30%
• Revenue growth: 20% (years 1-5), 10% (years 6-10)
• Tax rate: 25%
• Capex: 5% of revenue (low for software)
• Working capital: Minimal (SaaS receives cash upfront)
• WACC: 10%
• Terminal growth: 3%
• Shares outstanding: 100M
• Net debt: $500M

DCF Calculation:

Projected Free Cash Flows (Simplified):

Year	Revenue	EBITDA (30%)	FCF (after tax & capex)	PV (10% discount)
Year 1	$1,200M	$360M	$210M	$191M
Year 2	$1,440M	$432M	$252M	$208M
Year 3	$1,728M	$518M	$302M	$227M
...	...	...	...	...
Year 10	$3,797M	$1,139M	$664M	$256M

Sum of PV (Years 1-10): $2,300M

Terminal Value Calculation:

• Year 10 FCF = $664M
• Terminal Value = $664M × (1.03) / (0.10 - 0.03) = $9,787M
• PV of Terminal Value = $9,787M / (1.10)¹⁰ = $3,774M

Enterprise Value:

EV = $2,300M (PV years 1-10) + $3,774M (PV terminal) = $6,074M

Equity Value:

Equity Value = $6,074M - $500M (net debt) = $5,574M

Intrinsic Value per Share:

$5,574M / 100M shares = $55.74 per share

Investment Decision:
If stock trades at $40 → BUY (28% upside, 28% margin of safety)
If stock trades at $60 → WAIT (7% overvalued, no margin of safety)
If stock trades at $80 → SELL (43% overvalued)

Sensitivity Table: CloudCo Valuation Range

Intrinsic value per share based on WACC and terminal growth assumptions:

WACC ↓ / Terminal Growth →	2%	3%	4%
8%	$72.30	$78.50	$86.20
10%	$51.20	$55.74	$61.40
12%	$38.90	$42.10	$46.00

Valuation range: $38.90 (conservative) to $86.20 (optimistic)

Prudent approach: Use conservative assumptions (10% WACC, 3% terminal growth) → $55.74. Only buy if market price offers 30%+ discount ($39 or below).

Price/Earnings (P/E) Ratio

Formula: P/E = Market Cap / Net Income (or Stock Price / EPS)

What it means: How much investors pay per dollar of earnings

Typical ranges:

• High-growth tech: 25-50x (sometimes 100x+ if unprofitable but path to profitability)
• Stable consumer staples: 15-25x
• Cyclical industrials: 8-15x
• Banks/mature businesses: 8-12x

When to use: Companies with consistent, positive earnings

Caution: Doesn't work for unprofitable companies or highly cyclical earnings

EV/EBITDA (Enterprise Value / Earnings Before Interest, Taxes, Depreciation, Amortization)

Formula: EV/EBITDA = (Market Cap + Debt - Cash) / EBITDA

What it means: How much you pay (including debt) per dollar of operating earnings (before financing costs)

Why better than P/E:

• Adjusts for capital structure (debt levels don't distort comparison)
• Removes accounting differences (depreciation methods)
• Works for unprofitable companies (if EBITDA positive)

Typical ranges:

• High-growth SaaS: 15-30x
• Stable businesses: 8-15x
• Mature/cyclical: 5-10x

When to use: Comparing companies with different capital structures or for M&A valuation

Price/Sales (P/S) Ratio

Formula: P/S = Market Cap / Revenue

What it means: How much investors pay per dollar of revenue

When to use: Unprofitable companies (especially high-growth tech, biotech pre-revenue)

Typical ranges:

• Hypergrowth SaaS (pre-profit): 10-30x revenue
• Profitable SaaS: 5-15x revenue
• Retailers: 0.5-2x revenue
• Mature industrials: 0.5-1.5x revenue

Caution: Revenue quality varies widely—$1 of SaaS revenue (90% gross margin, recurring) ≠ $1 of retail revenue (20% gross margin, one-time)

Price/Book (P/B) Ratio

Formula: P/B = Market Cap / Book Value of Equity

What it means: How much investors pay per dollar of net assets

When to use: Asset-heavy businesses (banks, insurance, real estate, industrials)

Typical ranges:

• High-ROE businesses (Apple, software): 5-20x book
• Banks (well-run): 1.5-2.5x book
• Banks (struggling): 0.5-1.0x book (trading below liquidation value)
• Mature industrials: 1-3x book

Buffett's use: "We buy at 1.2x book or below" (Berkshire buyback threshold)

Caution: Meaningless for asset-light businesses (software has tiny book value, huge earnings)

PEG Ratio (Price/Earnings-to-Growth)

Formula: PEG = P/E Ratio / Earnings Growth Rate

What it means: Adjusts P/E for growth—helps compare fast-growers to slow-growers

Rule of thumb:

• PEG < 1.0: Undervalued (paying less than growth rate)
• PEG = 1.0: Fair value (P/E equals growth)
• PEG > 2.0: Overvalued (paying premium for growth)

Example:

• Company A: 40x P/E, 40% growth → PEG = 1.0 (fair)
• Company B: 15x P/E, 30% growth → PEG = 0.5 (cheap for growth)
• Company C: 50x P/E, 10% growth → PEG = 5.0 (very expensive)

Peter Lynch's rule: "A fairly priced growth stock should have a PEG ratio of 1.0. Below 0.5 is attractive, above 2.0 is expensive."

Example: Valuing "CloudCo" Using Comps

Step 1: Select Comparable Companies (Similar Business Model, Growth, Margins)

Peers: Salesforce, ServiceNow, Workday, HubSpot (all enterprise SaaS)

Step 2: Gather Trading Multiples

Company	P/E (NTM)	EV/Revenue	EV/EBITDA	Revenue Growth
Salesforce	42x	7.5x	22x	12%
ServiceNow	65x	12x	35x	22%
Workday	38x	6x	18x	16%
HubSpot	150x	10x	50x	28%
Median	53.5x	8.75x	28.5x	19%

Step 3: Apply Multiples to CloudCo

CloudCo financials: Revenue $1,200M (NTM), EBITDA $360M (NTM), Net Income $180M (NTM), Net Debt $500M

Multiple	Calculation	Implied EV or Market Cap	Equity Value	Price per Share
P/E (53.5x)	53.5 × $180M	$9,630M (Mkt Cap)	$9,630M	$96.30
EV/Revenue (8.75x)	8.75 × $1,200M	$10,500M (EV)	$10,000M	$100.00
EV/EBITDA (28.5x)	28.5 × $360M	$10,260M (EV)	$9,760M	$97.60

Valuation Range: $96-$100 per share
Compare to DCF: $55.74 per share (DCF) vs. $98 (median comps)
Interpretation: Market is valuing CloudCo at ~75% premium to DCF intrinsic value. Either (1) market is overpaying, or (2) your DCF assumptions are too conservative (growth could be higher than modeled).

Recent SaaS M&A Transactions (2022-2024)

Target	Acquirer	Deal Value	EV/Revenue	EV/EBITDA
Anaplan	Thoma Bravo	$10.7B	14x	45x
Citrix	Vista Equity + Evergreen	$16.5B	5x	18x
Zendesk	Private Equity Consortium	$10.2B	7x	28x
Median	—	—	7x	28x

Implied CloudCo Valuation (M&A Scenario):

• EV/Revenue (7x): $1,200M × 7 = $8,400M EV → $7,900M equity → $79 per share
• EV/EBITDA (28x): $360M × 28 = $10,080M EV → $9,580M equity → $95.80 per share

Interpretation: If CloudCo were acquired, a buyer might pay $80-$96 per share (including control premium). As a public minority shareholder, you shouldn't pay this price—wait for the market to offer a discount.

Berkshire Hathaway's Operating Segments (Simplified)

Step 1: Identify Segments and Choose Appropriate Valuation Method

1. Insurance (GEICO, Berkshire Hathaway Re): Value at 1.3x book value (insurance industry standard)
2. BNSF Railway: Value at 10x EBITDA (railroad industry standard)
3. Berkshire Hathaway Energy: Value at 12x EBITDA (utility standard)
4. Manufacturing, Service, Retail: Value at 8x EBITDA (diversified industrials)
5. Public Stock Portfolio (Apple, Coca-Cola, etc.): Use market value (mark-to-market)
6. Cash & Equivalents: Face value

Step 2: Calculate Segment Values

Segment	Method	Metric	Multiple	Value
Insurance	P/B	$140B book	1.3x	$182B
BNSF Railway	EV/EBITDA	$12B EBITDA	10x	$120B
BH Energy	EV/EBITDA	$7B EBITDA	12x	$84B
Manufacturing/Other	EV/EBITDA	$15B EBITDA	8x	$120B
Stock Portfolio	Market Value	—	1.0x	$300B
Cash	Face Value	—	1.0x	$150B
Total Intrinsic Value:				$956B
Shares Outstanding:				1.4M (Class A equiv.)
Intrinsic Value per Share:				$683,000

Investment Decision:
If Berkshire Class A trades at $550,000 → BUY (19% discount to SOTP intrinsic value)
If Berkshire Class A trades at $750,000 → SELL (10% premium to intrinsic value)

Note: Buffett uses a simpler metric—buys back Berkshire stock below 1.2x book value. SOTP analysis shows why: at 1.2x book, Berkshire typically trades at a discount to sum-of-the-parts intrinsic value.

Company: "RetailCo" (Struggling Retailer)

Balance Sheet:

• Cash: $100M
• Accounts receivable: $50M
• Inventory: $200M
• Property/Equipment: $300M
• Goodwill: $150M
• Total assets: $800M

• Current liabilities: $150M
• Long-term debt: $200M
• Total liabilities: $350M

Book value: $800M - $350M = $450M

Net-Net Working Capital (Liquidation Value):

• Cash: $100M (100%)
• Receivables: $50M × 0.85 = $42.5M
• Inventory: $200M × 0.50 = $100M (liquidation discount)
• PP&E: $0 (assume worthless in distressed sale)
• Goodwill: $0 (intangible, no liquidation value)
• Total liquidation assets: $242.5M

Liquidation value = $242.5M - $350M liabilities = -$107.5M (insolvent)

Conclusion: RetailCo is worth $450M as a going concern (book value), but only -$107M in liquidation. If business deteriorates, equity could be wiped out. Avoid unless trading at deep discount to book with credible turnaround plan.

Company: "IndustrialCo" (Stable, Low-Growth Manufacturing)

• Recent earnings (average of last 5 years): $500M/year
• One-time items to remove: $50M restructuring charge (year 3), $30M asset sale gain (year 4)
• Normalized earnings: $500M - $30M gain + $10M annual restructuring = $480M
• Maintenance capex: $100M/year (required to sustain current earnings)
• Normalized free cash flow: $480M - $100M = $380M
• Tax rate: 25%
• Cost of capital: 10%

EPV Calculation:

EPV = $380M / 0.10 = $3,800M

Per Share (100M shares outstanding, $200M net debt):

Equity value = $3,800M - $200M = $3,600M
EPV per share = $3,600M / 100M = $36 per share

Investment Decision:
If stock trades at $25 → BUY (30% discount to EPV, margin of safety)
If stock trades at $40 → HOLD (slight premium, but could be justified by hidden growth)
If stock trades at $55 → SELL (53% premium, pricing in growth that may not materialize)

Example: Full Valuation Analysis of CloudCo

Method	Intrinsic Value per Share	Weight	Notes
DCF (Conservative)	$55.74	40%	Most theoretically sound
Comparable Companies	$98.00	30%	Market-based reality check
Precedent Transactions	$87.40	15%	M&A scenario (includes premium)
EPV (Zero Growth)	$42.00	15%	Conservative floor
Weighted Average	$72.50	100%	—

Valuation Range: $42 (floor) to $98 (ceiling)

Central estimate: $72.50

Investment Decision Framework:
Strong Buy: <$51 (30%+ margin of safety to weighted average)
Buy: $51-$65 (10-30% margin of safety)
Hold: $65-$80 (fair value range)
Sell: >$80 (overvalued vs. weighted average)

The problem: Terminal value often represents 60-80% of total DCF value, but it's based on assumptions 10+ years out (highly uncertain).

Solution:

• Use conservative terminal growth rates (2-3%, not 5%)
• Run sensitivity analysis on terminal assumptions
• Cross-check with EPV (zero-growth baseline)

Buffett's approach: "If a business depends on terminal value 10 years out to be attractive, it's too uncertain. We want businesses that are obviously cheap based on near-term cash flows."

The problem: Comparing a 40% margin SaaS business to a 10% margin legacy software company using the same P/E multiple.

Solution:

• Adjust multiples for growth, margins, ROIC
• Use regression analysis (e.g., P/E vs. ROE scatter plot)
• Select truly comparable peers (not just same industry)

Example: Adobe (high-margin SaaS, 90% gross margin) deserves 40x P/E. Oracle (lower-margin legacy, 70% gross margin) deserves 20x P/E. Don't average them to value a SaaS startup.

The problem: Two companies with identical P/E ratios, but one has $5B cash, the other has $5B debt (very different risk profiles).

Solution:

• Always use enterprise value multiples (EV/EBITDA, EV/Revenue) to account for debt
• Adjust for off-balance-sheet liabilities (pensions, leases)
• Favor companies with net cash (optionality to deploy capital)

The problem: "Stock is down 50% from highs, so it must be cheap."

Reality: Stock could have been absurdly overvalued at peak, still overvalued after 50% decline.

Solution:

• Value the business from scratch, ignore price history
• Ask: "If I had never seen this stock before, what would I pay for it?"
• Compare to intrinsic value, not to 52-week high/low

Example: Zoom (ZM) at peak COVID (2020): $550/share (100x sales). Down 90% to $55 (2022). Still not cheap at 10x sales for a slowing-growth business. Down 90% ≠ undervalued.

The problem: Wall Street analyst price targets are 12-month predictions, not intrinsic value estimates.

Difference:

• Price target: "Where will the stock trade in 12 months?" (market sentiment forecast)
• Intrinsic value: "What is the business fundamentally worth?" (present value of cash flows)

Buffett/Munger ignore price targets: "We don't care where the stock will be in 12 months. We care what the business will earn over 10-20 years."

Essential Valuation Books

• "Valuation: Measuring and Managing the Value of Companies" by McKinsey & Company – The Wall Street bible (700+ pages, comprehensive)
• "Investment Valuation" by Aswath Damodaran – NYU professor, the authority on DCF and multiples
• "Value Investing: From Graham to Buffett and Beyond" by Bruce Greenwald – EPV method, Columbia Business School approach
• "Security Analysis" by Benjamin Graham – The original text (1934), asset-based valuation

Buffett & Munger on Valuation

• Berkshire Hathaway 1992 letter – Buffett's definitive explanation of intrinsic value
• "The Essays of Warren Buffett" – Valuation sections compiled by Lawrence Cunningham
• Berkshire annual meeting transcripts – Q&A on valuation methodology

Online Resources

• Damodaran Online: pages.stern.nyu.edu/~adamodar/ (free datasets, spreadsheets, valuation tools)
• SEC EDGAR: sec.gov/edgar (financial statements, 10-Ks, proxies)
• CapitalIQ, Bloomberg, FactSet: Professional data terminals (expensive, but industry standard)

Related Articles on PlanMyRetire.com

• Margin of Safety: The Foundation of Intelligent Investing
• Cash Flow Analysis: The Most Important Business Health Indicator
• Business Moats & Quality: Finding Exceptional Companies
• Management Quality Assessment: Evaluating Capital Allocators