Short answer
In most cases, both. Discounted cash flow measures value by the cash the business itself will generate and captures what is specific to the company. Multiples show how the market prices similar companies. Used together, each tests the other, and the gap between them is often the most useful information in the valuation.
How discounted cash flow works
Discounted cash flow projects the free cash flow the business will generate over the coming years and brings it back to present value at a rate that reflects risk, usually the weighted average cost of capital. Beyond the explicit horizon, a terminal value represents the business from then on.
The method's strength is capturing what is specific to the company: growth, margins, investment, working capital and risk. Its weakness is sensitivity to assumptions. Small changes in the discount rate or long-term growth move value a lot, and the terminal value often accounts for a large share of the total.
How multiples work
Multiples compare the company with similar ones using metrics such as enterprise value to EBITDA or to revenue. References can come from listed companies or from completed transactions.
The strength is the link to the market: a multiple shows what investors are paying today for similar businesses. The weakness is comparability. Size, growth, margins, liquidity and market timing vary widely, and for mid-market private companies truly comparable references are often scarce.
When each method carries more weight
- Discounted cash flow carries more weight for companies with predictable cash generation, for projects with a defined schedule and when the business plan changes the company's profile.
- Multiples carry more weight in mature sectors with many comparable companies and transactions, and as a quick reference in negotiations.
- Adjusted net assets make more sense for holding companies, real-asset businesses and companies whose value lies more in their assets than in their operations.
When the two disagree
It is common for DCF and multiples to point to different values. There is usually a reason: the company grows faster or slower than its peers, has different margins, is smaller and less liquid, or the market is paying above or below its historical average at that moment.
Explaining that gap is often the most useful part of the work. In a negotiation, it shows exactly which assumptions separate buyer and seller.
Three things to get right in any valuation
- Normalize earnings. Remove one-off effects, such as non-recurring gains, extraordinary expenses or owner compensation out of line with the market, before projecting or applying multiples.
- Bridge from enterprise value to equity value. Enterprise value includes debt. To reach the value to shareholders, deduct net debt and debt-like items, such as material employee or tax liabilities.
- Fix the valuation date. Value is measured at a point in time. Results, debt and cash must all refer to that date.
Decision-support valuations and formal reports
A valuation to support a decision or a negotiation is different from a report required by law, accounting standards or a regulator, which follows its own requirements for form, methodology and signatory. Before starting, confirm which one the situation calls for.
DCF and multiples, with explicit assumptions and a value range.
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