Which valuation method gives the highest valuation? (2024)

FAQs

Which valuation method gives the highest valuation? ›

This is the rough order and the rationale: Comparable transaction analysis – In general, comparable transactions > comparable companies. Comparable transactions include the premium paid in a competitive bidding process and should yield the highest valuation in theory.

DCF – The Most Lucrative Valuation Method

Typically, the Discounted Cash Flow (DCF) method tends to give the highest valuation.

More often than not, business valuation professionals use at least two methods when valuing companies, the most common being the DCF method and comparable transactions. These methods are popular because they're widely understood, but also because the underlying numbers are easier to obtain.

LBO - Between LBOs and DCFs, the DCF should have a higher value because the required IRR (cost of equity) of an LBO should be higher than the public markets cost of equity in WACC for the DCF. The DCF should be discounted at a lower rate and yield a higher value than an LBO.

Earnings Multiplier

The earnings multiplier may be used instead of the times revenue method to get a more accurate picture of the real value of a company because a company's profits are a more reliable indicator of its financial success than sales revenue.

The Appraisal Institute defines highest and best use as “the reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, financially feasible and that results in the highest value.” Appraisers typically apply four tests to determine that use.

DCF Valuation is extremely sensitive to assumptions related to perpetual growth rate and discount rate. Any minor tweaking here and there, and the DCF Valuation will fluctuate wildly and the fair value so generated won't be accurate. It works best only when there is a high degree of confidence about future cash flows.

LBO and DCF are financial modeling methods for investment decisions, but they have different goals. LBO focuses on acquiring and managing a company to produce returns through operational improvements and sales. However, DCF estimates investment intrinsic value based on future cash flows.

Why does a DCF almost always produce a higher valuation than an LBO? ›

With a DCF, by contrast, you're taking into account both the company's cash flows in between now and its terminal value, so values tend to be higher. Note: Unlike a DCF, an LBO model by itself does not give a specific valuation.

LBO – An LBO usually yields a lower valuation. It is a leveraged buyout driven by IRR rather than strategic value. After all, the private equity fund wants to sell the company for a profit down the road. Here the numbers of the entire acquisition must add up.

The Discounted Cash Flow (DCF) method often yields the highest valuation. It projects future cash flows and discounts them to present value. To maximize business potential, understanding various valuation methods is crucial.

Therefore, income-based valuations are most reliable for businesses with stable, predictable cash flows. As previously noted, the income approach can be combined with the cost approach, which will allow the direct valuation of tangible assets and indirect valuation of intangible assets.

Highest in, first out (HIFO) is a method of accounting for a firm's inventories wherein the highest cost items are the first to be taken out of stock. HIFO inventory helps a company decrease their taxable income since it will realize the highest cost of goods sold.