Valuation: How Much Is a Company Worth?

Intrinsic Value vs. Market Price

The central question in investing: is this stock cheap or expensive? To answer this, you need both the market price (easy — it's on your phone) and an estimate of intrinsic value — what the business is fundamentally worth based on its future cash flows. Valuation is the art and science of estimating that number.

The legendary investor Benjamin Graham put it simply: "Price is what you pay. Value is what you get." When market price is well below intrinsic value, you have a margin of safety — room to be wrong and still not lose money. This is the core idea of value investing.

Relative Valuation: Multiples

The fastest way to value a company is to compare it to similar companies using valuation multiples — ratios that normalize price relative to some fundamental measure.

Price-to-Earnings (P/E):

P/E = Stock Price / Earnings Per Share (EPS)

A P/E of 20 means investors are paying $20 for every $1 of current annual earnings. Higher P/E implies the market expects faster growth. S&P 500 historical average P/E is ~15–16; during tech booms it's reached 30+. Growth stocks (Amazon, NVIDIA) trade at 40–100× earnings; "value stocks" trade at 8–12×.

Limitations: EPS can be manipulated. Negative earnings make P/E meaningless. Compare P/E only within the same industry — tech vs. utilities have different structural growth rates.

Enterprise Value to EBITDA (EV/EBITDA):

EV = Market Cap + Total Debt − Cash
EV/EBITDA = Enterprise Value / EBITDA

EV/EBITDA is preferred by professionals because it's capital-structure-neutral (works regardless of how much debt the company has) and pre-tax (comparable across tax jurisdictions). Typical ranges: 6–10× for mature industries, 15–25× for high-growth tech, 3–6× for capital-intensive businesses.

Price-to-Sales (P/S): Used for companies with no profits yet. Tech startups are often valued at 5–20× revenue.

Price-to-Book (P/B): Price relative to net assets (book value). Banks and financial companies are often analyzed this way. P/B below 1 means the stock is trading below its liquidation value — often signals distress or deep value.

Discounted Cash Flow (DCF): The Gold Standard

Multiples tell you relative valuation. DCF tells you absolute value. A DCF values a company by projecting its future free cash flows and discounting them back to today at a rate that reflects risk.

The core formula:

Intrinsic Value = Σ [FCF_t / (1 + r)^t] + Terminal Value

Where:

• FCF_t is free cash flow in year t
• r is the discount rate (typically the Weighted Average Cost of Capital, WACC)
• Terminal value captures all cash flows beyond your forecast horizon (usually 5–10 years)

Terminal value is typically estimated using the Gordon Growth Model:

Terminal Value = FCF_final × (1 + g) / (r − g)

where g is the long-term growth rate (usually 2–3%, roughly GDP growth). Terminal value often accounts for 60–80% of total DCF value — which is why small changes in assumptions can swing valuations dramatically.

The Problem With DCF

DCF sounds precise but is extremely sensitive to inputs. Changing the discount rate from 10% to 12%, or changing the terminal growth rate from 3% to 2%, can change the output by 30–50%. As the joke goes, "DCF stands for 'Don't Count on Figures.'" Wall Street analysts use DCF to justify predetermined conclusions at least as often as to discover them.

Good practice: use DCF alongside multiples, stress-test your assumptions, and focus on the range of possible values rather than a single point estimate.

A Simple Valuation Framework

1. Understand the business: How does it make money? How durable are its competitive advantages (moat)?
2. Check growth trajectory: Is revenue growing? Are margins expanding or contracting?
3. Assess the balance sheet: Can the company survive a downturn? Is debt manageable?
4. Compare multiples to peers: Is it trading at a premium or discount? Why?
5. Sanity-check with DCF: Do the multiples imply reasonable long-term growth assumptions?