Discount cash Flow Valuation Model

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Discount cash Flow Valuation Model

Any valuation method aims at estimating an asset’s value as precisely as possible. Yet, savvy analysts and investors know that estimating accurate asset values is highly unlikely due to market inefficiency that leads to wrong value assessments. Because markets are inefficient, assets are not priced correctly. However, as soon as new information becomes available about any asset, markets have the ability to correct themselves (efficient market hypothesis). Therefore, although market volatility makes accurate forecasting complicated, the projection of the expected cash flows in terms of growth rate or profit margin is facilitated as soon as new information becomes available for the asset. In efficient markets, the market price is the basis for estimating an asset’s value and any valuation method aims at justifying this value.

Today, most analysts use two popular valuation approaches, namely the discounted cash flow (DCF) valuation method and the relative valuation method, also known as multiples. Although they are both broadly applied tools for effective investment decision making, they differ in the way they estimate the value of an asset.

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