Valuation: the concept

A business is worth the cash it will generate for its owners over its life, adjusted for when that cash arrives and how risky it is. Everything else — multiples, comparables, target prices — is a shortcut to that idea. When a shortcut and the principle disagree, the principle wins.

Price is what the market currently pays. Value is what the cash flows justify. Banking work often consists of estimating value, then explaining why a buyer should pay a price close to it.

Intrinsic valuation (a DCF) estimates value from the company's own forecast. Relative valuation (trading comparables and precedent transactions) estimates value from what similar assets are priced at. Intrinsic methods capture specifics but depend on assumptions; relative methods reflect the market but import its mood.

Equity value is what the shareholders' stake is worth: share price times diluted shares. Enterprise value is the value of the operating business to all capital providers: equity value plus debt, preferred stock and minority interest, minus cash. It answers 'what would it cost to buy the whole business, free of financing?'

Match the multiple to the measure. Enterprise value pairs with metrics before interest (revenue, EBITDA, EBIT). Equity value pairs with metrics after interest (net income, earnings per share).

A buyer of the whole company receives its cash, which effectively reduces the price paid for the operations. Debt is added because the buyer must assume or repay it. Interviewers often ask what happens to enterprise value when a company raises debt and holds the cash: nothing, because debt and cash rise equally.

Every valuation is a range. Bankers present a 'football field' chart showing the range from each method, then argue where in that range the price should sit. Being able to explain why one method deserves more weight is the skill interviewers are probing.