DCF vs multiples: which valuation method should you choose?

Introduction: two philosophies of valuation, one business to price

Faced with the question "how much is this business worth?", two answers have opposed each other for decades: the DCF (discounted cash flow), which discounts expected future cash flows, and multiples, which transpose the price observed on comparable companies. The first seeks an intrinsic value. The second trusts the market.

According to professor Aswath Damodaran (NYU Stern), in intrinsic valuation, the value of an asset is estimated based upon its cash flows, growth potential and risk; in relative valuation, we value an asset by looking at how the market prices similar assets.

"While the focus in classrooms and academic discussions remains on discounted cash flow valuation, the reality is that most assets are valued on a relative basis.", Aswath Damodaran, NYU Stern, The Little Book of Valuation.

This tension between theory and practice is not an academic detail. The choice of method changes the value obtained, the level of proof required when facing a buyer, a co-shareholder or a tax authority, and the time needed to produce a defensible figure. This article defines the two methods, explains why they do not really oppose each other, details when to favour one over the other, then presents two worked examples, one in France and one in Switzerland, before a FAQ of ten questions.

• DCF: present value of expected future cash flows, based on a business plan and a discount rate.
• Multiples: value derived from the price paid for comparable companies, listed or transacted.
• Intrinsic value: value estimated independently of the observed market price.
• Relative value: value derived from observed market prices on comparable assets.
• Terminal value: value attributed to cash flows beyond the explicit projection horizon of a DCF.

Secure your choice of method before presenting your valuation

The choice between DCF and multiples, or their combination, commits the credibility of a valuation when facing a buyer, a co-shareholder or a tax authority. A no-obligation thirty-minute discussion with Hectelion helps frame the most defensible method for your situation, through our booking calendar.

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Definition: what are the DCF and the multiples method?

DCF: a quick definition

The DCF discounts the business's expected future free cash flows, projected over an explicit horizon, plus a terminal value beyond that horizon, at the weighted average cost of capital. The method falls under the income approach as defined by the IVSC standards. The choice between free cash flow to the firm and free cash flow to equity is covered in a dedicated article.

Multiples: a quick definition

The multiples method applies to a business aggregate, EBITDA, EBIT or revenue, a multiple observed on comparable companies, listed (trading multiples) or transacted, that is, negotiated in an actual merger or acquisition (transaction multiples). It falls under the market approach as defined by the same IVSC standards.

Direct and indirect multiples: two routes to equity value

Within the multiples method, a first distinction separates multiples according to the aggregate the price is related to.

• Direct approach: a multiple that relates a price to an aggregate accruing to shareholders, such as the P/E ratio, gives equity value directly, with no intermediate step.
• Indirect approach: a multiple that relates a price to an operating aggregate, before the effect of the capital structure, such as EV/EBIT or EV/Sales, first gives enterprise value, which must then be adjusted for net debt and debt-like items to reach equity value.

The direct approach avoids the net debt bridge step, but remains more sensitive to differences in capital structure and taxation between comparables. The indirect approach largely neutralises the effect of leverage, at the cost of a net debt bridge that must be built rigorously.

Trading multiples and transaction multiples: two sources of comparables

A second distinction, independent of the first, separates multiples according to the origin of the observed price.

• Trading multiples: computed on listed companies, from prices observed continuously on a liquid market. They reflect minority block trades and do not embed a control premium.
• Transaction multiples: computed on actually negotiated mergers and acquisitions. They most often embed a control premium, since they reflect the price paid for a controlling stake, but rest on information that is rarer and sometimes less homogeneous than trading prices.

These two distinctions combine freely: a trading multiple can be direct (a listed P/E) or indirect (a listed EV/EBITDA), and the same applies to a transaction multiple.

Origin: two approaches recognised by international valuation standards

The international valuation standards (IVSC) distinguish three recognised approaches: the income approach, of which the DCF is the most widespread method, the market approach, of which multiples are the most widespread method, and the cost approach. Neither is a recent invention: the DCF rests on the present-value theory developed in the twentieth century, multiples on the empirical observation of market prices, a practice as old as transactions themselves.

Damodaran notes that this opposition is partly artificial: a multiple is never anything more than a shortcut that condenses, into a single figure, the assumptions a DCF makes explicit one by one.

Why compare the DCF and multiples rather than choose out of habit?

• The DCF makes explicit what multiples condense. A growth, risk or margin assumption, implicit in a multiple, becomes visible and debatable in a DCF.
• Multiples anchor the value in the market. They avoid the drift of an overly optimistic business plan, at the cost of a dependence on the availability of relevant comparables.
• The two methods require different data. The DCF requires a detailed business plan and a discount rate; multiples require a sufficiently homogeneous sample of comparables.
• The context of the valuation drives the choice. A fundraising, a sale, a dispute between shareholders or a tax return do not require the same level of proof or the same method.
• Triangulation reduces the risk of error. Making a DCF and a multiples-based valuation converge on a similar order of magnitude strengthens the credibility of the result far more than either method used alone.

How are a DCF and a multiples-based valuation put together?

The two methods follow distinct steps.

• DCF: build a business plan, project free cash flows over an explicit horizon, compute a terminal value, determine the weighted average cost of capital, discount the whole, then move from enterprise value to equity value by deducting net debt.
• Multiples: select a sample of relevant comparables, compute their observed multiples, retain a central value or a range, apply it to the aggregate of the business being valued, then adjust the result for any premiums or discounts specific to the company.

Data required	DCF	Multiples
Business plan	Essential, detailed	Not essential
Comparables	Not needed	Essential, homogeneous
Discount rate	To be calculated (WACC)	Implicit in the multiple
Sensitivity	High to terminal value	High to the choice of comparables

When to favour the DCF over multiples?

The DCF suits a business whose growth or profitability profile resembles no available comparable, for example a young technology company still loss-making, or a company whose one-off investment temporarily distorts its aggregates. Multiples suit a business for which a sufficiently homogeneous sample of comparables exists, for example a mature company in a sector where transactions are well documented. In practice, the two methods are most often used together, the DCF to explore sensitivity to assumptions, multiples to anchor the result in observed transactions.

Whom to consult to decide between DCF and multiples?

Three criteria guide the choice of adviser.

• The availability of comparables: in their absence, a rigorous DCF becomes essential, which requires more advanced modelling than a simple application of a multiple.
• The level of proof required: a contentious sale or a tax audit requires a documented and defensible method, often both methods combined.
• The time available: a quick estimate relies more on multiples, a formal valuation on a full DCF.

Hectelion works on business valuation, aligned with IVSC standards and market practice, always combining DCF and multiples so that each method checks the other, and on financial due diligence, which underpins the assumptions used. Hectelion is not authorised by FINMA and does not work on listed transactions.

Advantages: rigour, market anchoring, complementarity

The DCF offers analytical rigour: every assumption is explicit and can be discussed, negotiated or corrected. Multiples offer a market anchor: they reflect what real buyers have actually paid. Used together, the two methods offer complementarity that reduces the risk of relying on a bias specific to a single approach.

Limits: assumptions, comparability, circularity

The DCF remains highly sensitive to the assumptions used, in particular the terminal value, which often represents the majority of total value. Multiples remain highly sensitive to the real comparability of the sample used, rarely perfect in practice. Finally, a form of circularity links the two methods: a multiple observed in the market already implicitly embeds growth and risk assumptions that a DCF makes explicit separately.

Why every multiple carries an implicit DCF

Damodaran states this point precisely in his course on relative valuation.

"Proposition 2: Embedded in every multiple are all of the variables that drive every discounted cash flow valuation: growth, risk and cash flow patterns.", Aswath Damodaran, NYU Stern, Relative Valuation, p. 15.

In practice, two comparable companies that show a different EBITDA multiple do not differ by chance: the gap almost always reflects a difference in expected growth, perceived risk or the profile of converting earnings into cash, the very same variables a DCF quantifies explicitly. Understanding this equivalence allows a multiple to be used more critically, by asking what growth or risk assumption it implicitly validates for the business being valued.

Football field: visualising the convergence of the DCF and multiples

The football field is the standard tool, recognised by the IVSC standards, for presenting the results of several methods together. It takes the form of a horizontal bar chart, each bar showing the value range obtained by one method: DCF, trading multiples, transaction multiples, and where relevant an asset-based method. The bars are stacked below one another, which makes it possible to see at a glance where several methods overlap.

Illustrative example: the three methods converge on a suggested range of 35 to 36 million, the most defensible value.

This overlap zone is generally the most defensible: a value that appears under only one method must be explained, not simply retained because it is the most favourable. The football field thus makes visible, in a single chart, the triangulation logic developed throughout this article.

Implied multiple: what the DCF reveals about the price paid

Damodaran's proposition becomes operational as soon as it is applied to a concrete case. In Case 1, the enterprise value of EUR 8,000,000 obtained by DCF, divided by the ARR of EUR 2,000,000, corresponds to an implied multiple of 4x ARR. This figure can then be compared with transaction multiples observed on comparable companies, to check that the DCF does not lead to a value disconnected from the market.

In Case 2, the reasoning runs in the other direction. The 6x multiple used for the transaction can be cross-checked against the assumptions a DCF would need to make to reach the same order of magnitude: a modest stable growth rate and a risk-return profile consistent with a mature industrial SME. If these implicit assumptions look unreasonable once made explicit, the multiple used deserves a second look before being presented as a defensible value.

The five mistakes to avoid

Mistake 1: choosing the DCF or multiples out of habit, without examining the context

The availability of comparables, the maturity of the business and the level of proof required should determine the method, not a personal methodological preference.

Mistake 2: applying an average sector multiple without checking real comparability

An average sector multiple applied without adjusting for size, growth or risk leads to a value that does not reflect the business actually being valued.

Mistake 3: neglecting the DCF's sensitivity to terminal value

When the terminal value represents the majority of total value, a modest change in the growth rate or the discount rate significantly changes the result. This sensitivity must be tested and presented.

Mistake 4: confusing a Swiss tax value with a transaction value

In Switzerland, the value used for wealth tax on unlisted shares follows the formula of the Swiss Tax Conference, weighting the earnings value and the net asset value, which corresponds neither to a DCF nor to a transaction multiples valuation. The two values answer different questions.

Mistake 5: presenting a single method when triangulation was possible

When the data allow it, presenting only a DCF or only a multiples-based valuation deprives the valuation of a cross-check that strengthens its credibility with a buyer or a tax authority.

Case 1: a young French technology company with no relevant comparable

A French SaaS company, four years old, shows annual growth of 60% and a still-negative result. No comparable listed or transacted company in France shows a similar growth and profitability profile. The valuer uses a DCF over an explicit five-year horizon, with a weighted average cost of capital incorporating a specific risk premium linked to the development stage, and obtains an enterprise value of EUR 8,000,000, for an annual recurring revenue (ARR) of EUR 2,000,000. An ARR multiple observed on North American transactions is used as a cross-check, but set aside as the primary method for lack of sufficient comparability with the French market. This example is illustrative.

Case 2: a Swiss industrial SME between transaction value and tax value

A stable, profitable Swiss industrial SME shows normalised EBITDA of CHF 7,000,000. It is valued at CHF 42,000,000 by a sector EV/EBITDA multiple of 6x, as part of a sale to an outside buyer. A non-selling minority shareholder must separately declare the value of its shares for wealth tax. Under the Swiss Tax Conference formula, E = (2 × Vr + Vs) / 3, with an earnings value of CHF 50,000,000 and a net asset value of CHF 20,000,000, the tax value comes out at CHF 40,000,000, close to but distinct from the transaction value. The two values answer two different questions and do not substitute for one another. This example is illustrative.

A word from the founder

"The DCF and multiples are not two opposing camps. A poorly understood multiple is often a DCF that nobody bothered to make explicit.", Aristide Ruot, founder of Hectelion SA.

"In our mandates, we always present both methods together. When they converge, the valuation becomes hard to challenge. When they diverge, it means an assumption deserves a second look.", Aristide Ruot, founder of Hectelion SA.

FAQ: the 10 essential questions on the DCF and multiples

Introduction: what to remember before the questions

The questions below cover the points that come up most often when choosing between a DCF and a multiples-based valuation.

Q1: Is the DCF more reliable than multiples?

Neither is inherently more reliable. The DCF makes its assumptions explicit but is highly sensitive to them. Multiples anchor the value in the market but depend on the real comparability of the sample.

Q2: Can DCF and multiples be combined in the same valuation?

Yes, this is the most robust practice. Making the two methods converge on a similar order of magnitude strengthens the credibility of the result with a buyer or a tax authority.

Q3: Why does a multiple already contain a DCF's assumptions?

Because a market price implicitly embeds an expectation of growth, risk and cash generation, the very same variables a DCF quantifies explicitly.

Q4: What should be done in the absence of relevant comparables?

A DCF then becomes the primary method, possibly supplemented by multiples from related markets or sectors, used as a cross-check rather than as the reference method.

Q5: Why does terminal value weigh so heavily in a DCF?

Because it represents the value of cash flows beyond the explicit projection horizon, often the majority of total value, which makes it highly sensitive to the growth rate and discount rate used.

Q6: Can a company's Swiss tax value serve as the basis for a sale?

No, in principle. The Swiss Tax Conference formula answers a tax question, wealth tax, and is not intended to reflect a negotiable market price between a seller and a buyer.

Q7: Do trading multiples and transaction multiples give the same value?

Not necessarily. Transaction multiples often embed a control premium absent from trading multiples, which reflect minority block trades.

Q8: Should an average sector multiple be adjusted?

Yes, taking into account the size, growth, risk and profitability specific to the business being valued, rather than applying it as is.

Q9: Does a DCF suit a long-established, barely profitable company?

In that case, the business plan used must be checked for realism, and the terminal value must not assume an undocumented turnaround, or the value will be overstated.

Q10: How should two methods giving different results be presented?

By explaining the source of the gap, often a diverging growth or risk assumption, rather than by retaining the method that gives the most favourable result.

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Conclusion: the DCF explains, multiples confirm

The DCF and multiples do not answer the same question. The first makes explicit the growth, risk and cash-generation assumptions that underpin the value of a business. The second observes what the market has actually paid for comparable companies. Damodaran showed this precisely: a multiple is never anything more than a condensed DCF, whose assumptions remain implicit until they are made explicit.

Choosing between the two methods therefore rarely means picking a side between two schools of thought. It means determining which can be documented most rigorously in the specific case, then checking, whenever the data allow it, that the other method leads to a similar order of magnitude.

Hectelion systematically combines both approaches in its valuation mandates, so that they check one another rather than excluding each other, alongside the legal and tax advice needed depending on the context of the transaction.

Summary of the article

The DCF discounts a business's expected future cash flows, at the weighted average cost of capital, and makes explicit every growth and risk assumption. The multiples method applies to a business aggregate a multiple observed on comparable companies, listed or transacted, and anchors the value in actually observed market prices.

The two methods do not really oppose each other: a multiple implicitly condenses the same variables a DCF makes explicit. The availability of relevant comparables, the maturity of the business and the level of proof required drive the choice of the primary method, the two being most often combined.

In Switzerland, the value used for wealth tax on unlisted shares follows a distinct formula, set by the Swiss Tax Conference, which substitutes for neither a DCF nor a transaction multiples valuation.

Sources

• Aswath Damodaran, NYU Stern, The Little Book of Valuation, Intrinsic vs Relative Value
• Aswath Damodaran, NYU Stern, Relative Valuation
• Swiss Tax Conference, circular no. 28, instructions on the estimation of unlisted securities
• International Valuation Standards Council, international valuation standards

Author

Aristide Ruot, Ph.D.
Founder | Chief Executive Officer, Hectelion SA