Discounted Cash Flow (DCF)
DCF calculates the intrinsic value of a stock based on expected future free cash flows, discounted to present value at the appropriate discount rate (WACC).
Steps in DCF
- Project Free Cash Flows (FCF) for 5–10 years
- Calculate Terminal Value: TV = FCFn × (1+g) / (WACC − g) [Gordon Growth Model]
- Discount all cash flows and TV to present value using WACC
- Enterprise Value = PV of FCFs + PV of TV
- Equity Value = Enterprise Value − Net Debt
- Per share value = Equity Value / Shares outstanding
Key assumptions: Terminal growth rate (g) is critical — small changes cause large value swings. Sensitivity analysis on WACC and g is mandatory for DCF credibility.
Comparable Company Analysis (Comps)
Values a company by comparing its multiples to peers in the same sector.
| Multiple | Formula | Used for |
|---|---|---|
| EV/EBITDA | Enterprise Value / EBITDA | Most widely used — capital structure neutral |
| P/E | Share Price / EPS | Mature, stable businesses |
| P/B | Share Price / Book Value per Share | Banks, NBFCs, asset-heavy businesses |
| P/S | Market Cap / Revenue | Early-stage, loss-making growth companies |
| EV/Sales | Enterprise Value / Revenue | Same as P/S but capital-structure neutral |
Dividend Discount Model (DDM)
Values a stock based on present value of future dividends.
P₀ = D₁ / (Ke − g)
Where D₁ = next year's expected dividend, Ke = cost of equity, g = dividend growth rate.
Applicable for: High dividend-paying, mature companies with stable payout ratios (banks, FMCG, telecom). Not useful for growth companies that pay no dividends (tech startups).
Sum-of-Parts (SOTP)
For conglomerates or companies with diverse business segments, each segment is valued separately using the most appropriate method, then summed.
Example: Reliance Industries — O&G segment (DCF), Retail (EV/EBITDA comps), Telecom (EV/subscriber comps). Add listed subsidiaries at market value. Subtract holding company discount (20–30%).