Corporate Finance Internships: Understanding Key Valuation Methods - Multiples vs. Discounted Cash Flow

Whether you're considering a corporate finance internship or an M&A internship, preparing for jobs, or assuming a role as a CFO with the intention to merge or acquire another company, understanding the techniques for company valuation is essential. In the realm of corporate finance, two methods predominantly used for this purpose are the Multiples method and the Discounted Cash Flow (DCF) method. This article dives into these two techniques, exploring their advantages, limitations, and ideal use-cases.

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Multiples Method

The Multiples approach values a company by comparing its key statistics with those of similar companies or previous deals. For instance, the price-to-earnings (P/E) ratio of different companies in the same industry could be compared, with the average or median ratio applied to the target company's earnings to estimate its value. Other commonly used multiples include price-to-sales, price-to-book, and enterprise value-to-EBITDA.

‍Pros: The Multiples method is simple, quick, and widely used. With public sources providing easily accessible financial data, calculating the multiples requires minimal assumptions.

‍Cons: This method can also be misleading, inconsistent, and subjective. Finding truly comparable companies can be a challenge, and adjustments might be necessary to account for different accounting practices, growth rates, risk profiles, and capital structures. The choice of multiple to use and their weight can also be subjective.

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Discounted Cash Flow (DCF) Method

DCF, on the other hand, forecasts future cash flows to determine the company's current value, accounting for risk and time. This direct valuation technique values a company by projecting its future cash flows and then using the Net Present Value (NPV) method to value those cash flows. DCF is a widely used valuation technique across investment banking, internal corporate finance, business development, and academic circles.

Pros: Theoretically, DCF is considered the most sound method if the analyst is confident in their assumptions. It isn’t significantly influenced by temporary market conditions or non-economic factors and is especially useful when there is limited or no comparable information.

Cons: The DCF method can be time-intensive relative to other valuation techniques and its outcomes are highly sensitive to numerous assumptions and forecasts, hence, can vary significantly. This method involves forecasting future performance, which can be challenging.

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Choosing Between Multiples and DCF

So, when should you use DCF instead of a multiple valuation? 

• Multiples are indeed more suitable for quicker valuations, especially when you want to understand how a company is valued relative to its peers. It's a high-level view and is often used as a starting point or sanity check in valuation exercises. 
• DCF, however, is better for detailed and comprehensive valuations. It allows for a detailed analysis and is highly sensitive to assumptions. The benefit is that it can capture the unique aspects, risks, and opportunities of the business being valued.

As a corporate finance and M&A professional, being able to reason whether to use Multiples or DCF (or both) is crucial. This choice should be based on the specific situation at hand, the data available, and the level of detail required. These valuation methods are tools in your arsenal, enabling you to make informed, strategic decisions in the fast-paced, high-stakes world of corporate finance.

Remember, whichever method you choose, your valuation is only as good as your understanding of the company and its industry. Therefore, continuous learning and a keen eye for detail are paramount in your journey towards a successful career in corporate finance or M&A. If you would like to learn more, see our other articles about DCF and Multiples.‍ Also check out our quizlet to practice!

At InFinance, we're here to help you navigate this journey. We believe in your potential, and we're committed to helping you realize it. We offer excellent and specialized resources that can guide you along the right path and help you land your dream corporate finance internship or M&A internship.

Reach out to us, and let's take the first step towards a thriving career in finance!

FAQs

1. As an intern, how much depth should I understand about these valuation methods?

Answer: While a basic understanding is essential, internships are also about learning on the job. Familiarize yourself with the core concepts, but remember you'll receive guidance and training throughout your internship. The goal is to understand the rationale behind each method and to recognize when to apply them.

2. Will I be expected to create DCF models from scratch during my internship?

Answer: It varies by firm and role. Some internships might involve assisting in building or refining parts of a DCF model, while others might focus more on data gathering or preliminary analysis. Always be prepared, but also expect mentorship and support in your tasks.

3. How can I best prepare for the valuation tasks I might encounter during my corporate finance internship?

Answer: Familiarize yourself with basic financial statements and the key principles of each valuation method. Practical experience, like case studies or mock valuations, can also be beneficial. Seek feedback from peers or mentors, and use online resources to bolster your understanding.

4. Are there common mistakes interns make when working with Multiples or DCF valuations?

Answer: Yes. Common mistakes include not selecting appropriate comparable companies for relative valuation, being overly optimistic with growth rates in DCF, and not double-checking inputs for errors. Always approach tasks methodically and ask questions if unsure.

5.  Can I use both Multiples and DCF methods together?

Answer: Absolutely! Many finance professionals use both methods to triangulate a range of values for a company. While DCF might give an intrinsic value, Multiples can provide a market-relative perspective. Using both can offer a more holistic view of a company's valuation.