Valuation Methods in Investment Banking
"What are the main valuation methodologies?" is asked in every single IB interview. Here's how each method works, when to use it, and the common interview traps around choosing between them.
The 3 Core Valuation Methods
Discounted Cash Flow (DCF)
Intrinsic ValueValues a company based on the present value of its future free cash flows. The most theoretically rigorous method.
Strengths
Limitations
Best For
Mature companies with predictable cash flows
Comparable Company Analysis
Relative Value (Minority)Values a company by comparing it to similar publicly traded companies. Reflects current market pricing and sentiment.
Strengths
Limitations
Best For
Quick valuation benchmarks, IPO pricing
Precedent Transactions
Relative Value (Control)Values a company based on what acquirers have paid for similar companies in past M&A deals. Includes control premium.
Strengths
Limitations
Best For
M&A advisory, sell-side valuations
The Valuation Football Field
In practice, analysts present all three methodologies side by side in a "football field" chart, horizontal bars showing the valuation range from each approach.
Typical Ordering (Highest to Lowest):
Note: This ordering is a general rule of thumb and varies by situation. The overlap zone is the most defensible valuation range.
Common Interview Questions
"Which method gives the highest value?"
Generally: Precedent transactions > DCF > Trading comps. Precedent includes control premium. But this varies, in hot markets, comps can exceed transactions.
"If you could only pick one method, which would you choose?"
DCF, because it's based on the company's intrinsic cash-generating ability, not market sentiment or deal-specific factors. But always cross-check with comps to verify reasonableness.
"When would you NOT use a DCF?"
Early-stage companies (no predictable cash flows), financial institutions (use DDM), and highly cyclical companies where a single forecast path is misleading.
"Why do precedent transactions include a control premium?"
Acquirers pay above market price for synergies, strategic control, and competitive bidding dynamics. The premium (typically 20-40%) reflects the value of owning 100% vs. holding a minority stake.
Master All Valuation Methods
DCF is Chapter 3. Comps are Chapter 4. M&A is Chapter 5. Plus Accounting, EV/Equity Value, LBOs, Advanced Valuation, and Complex Accounting. 80+ pages covering everything you'll be asked.