Intrinsic vs. Relative Valuation
The two ways to value a company: from its own cash flows (DCF) or by comparison to its peers (comps). Pros know when to lean on each.
- ✓Contrast intrinsic and relative valuation
- ✓List the benefits and drawbacks of each
- ✓Explain why analysts cross-check one against the other
There are two broad ways to value a business. Intrinsic valuation (the DCF) builds value from the company's own projected cash flows. Relative valuation (comparables, or 'comps') values the company by how similar businesses are priced in the market - multiples of revenue, , or earnings.
- ›Based on the company's own future
- ›Tied directly to financial theory
- ›Works even with few comparable companies
- ›But: highly sensitive to your assumptions
- ›And: your projections may differ from the market's view
- ›Based on how peers are currently priced
- ›Reflects live market sentiment
- ›Quick and grounded in real transactions
- ›But: can be distorted by market swings
- ›And: needs a clean set of comparable companies
There is no single 'right' answer. Different methods give different numbers on purpose - a big part of the job is understanding why they disagree and what each one is telling you.
In practice, analysts run both and triangulate. A DCF that lands wildly above or below where comparable companies trade is a signal to re-examine your assumptions - not necessarily proof the market is wrong, but a flag worth chasing down.
A company operates in a brand-new industry with no clean public comparables. Which method is more naturally suited to value it?