Glossary: Valuation Methodologies

This glossary defines 28 valuation terms with concise definitions focused on practical application. Terms are organized by category for reference during valuation work.

Core Value Concepts

Intrinsic Value: The estimated "true" worth of an asset based on fundamental analysis of cash flows, growth, and risk, independent of current market price. If intrinsic value exceeds market price, the asset may be undervalued.

Fair Value: The price at which an asset would exchange between a willing buyer and seller in an arm's length transaction. Distinct from intrinsic value in that it incorporates market conditions and transaction context.

Enterprise Value (EV): The total value of a business to all capital providers. EV = Market Cap + Total Debt - Cash + Preferred Stock + Minority Interest. Used as the numerator in EV-based multiples.

Equity Value: The value of a company available only to common shareholders. Equity Value = Enterprise Value - Net Debt. What you actually own when you buy shares.

Market Capitalization: Total market value of a company's outstanding common shares. Market Cap = Current Share Price x Shares Outstanding.

Book Value: Net asset value from the balance sheet. Book Value = Total Assets - Total Liabilities. Represents accounting value, not necessarily economic value.

DCF Components

DCF (Discounted Cash Flow): Valuation method that calculates the present value of expected future cash flows. The foundational intrinsic value approach.

FCFF (Free Cash Flow to Firm): Cash available to all capital providers (debt and equity). FCFF = EBIT(1-t) + Depreciation - CapEx - Change in Working Capital. Discount at WACC to get enterprise value.

FCFE (Free Cash Flow to Equity): Cash available to equity holders after debt obligations. FCFE = FCFF - Interest(1-t) + Net Borrowing. Discount at cost of equity to get equity value directly.

Terminal Value: The value of a business beyond the explicit forecast period in a DCF. Typically contributes 60-80% of total DCF value. Calculated using perpetuity growth or exit multiple methods.

Perpetuity Growth Rate: The assumed constant growth rate of cash flows forever in terminal value calculation. Should not exceed long-term GDP growth (typically 2-4% in developed markets).

Gordon Growth Model (GGM): Dividend discount model assuming constant dividend growth. V = D1 / (r - g). Requires r > g or produces invalid results.

Discount Rates

WACC (Weighted Average Cost of Capital): The blended cost of all capital sources weighted by their proportion in the capital structure. WACC = (E/V) x Ke + (D/V) x Kd x (1-t). Used to discount FCFF.

Cost of Equity (Ke): The return required by equity investors for bearing stock risk. Typically calculated using CAPM: Ke = Risk-free Rate + Beta x Equity Risk Premium.

Cost of Debt (Kd): The effective interest rate a company pays on its debt obligations. Often approximated by yield-to-maturity on the company's bonds.

Beta: A measure of a stock's volatility relative to the overall market. Beta of 1.0 means the stock moves with the market; >1.0 means more volatile; <1.0 means less volatile.

Equity Risk Premium (ERP): The additional return above the risk-free rate that investors require to hold equities. Historical average approximately 4-5%; Damodaran's implied ERP was 4.33% as of January 2025.

Valuation Multiples

P/E Ratio (Price-to-Earnings): Stock price divided by earnings per share. Trailing P/E uses past 12 months; Forward P/E uses next 12 months estimate. S&P 500 historical average: 15-20x.

EV/EBITDA: Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation, and Amortization. Capital structure-neutral multiple useful for comparing companies with different leverage. Ranges from 5x (oil & gas) to 28x (software).

EV/EBIT: Enterprise Value divided by Earnings Before Interest and Taxes. More conservative than EV/EBITDA because it includes depreciation as a real expense.

EV/Revenue: Enterprise Value divided by total revenue. Used for high-growth companies without profits. SaaS median approximately 6.9x as of 2024.

PEG Ratio: P/E Ratio divided by expected earnings growth rate. PEG < 1 may suggest undervaluation relative to growth; PEG > 2 may suggest overvaluation.

CAPE (Cyclically Adjusted P/E): Current price divided by average of 10 years of inflation-adjusted earnings. Smooths out business cycle effects. Also called Shiller P/E. Historical median: 16x; as of late 2024: approximately 39-40x.

Adjustments and Premiums

Control Premium: The additional amount paid above minority market value to acquire majority control of a company. Reflects the value of decision-making rights. Typically 10-30% above trading price.

DLOM (Discount for Lack of Marketability): A reduction in value applied to securities that cannot be easily sold on a public market. Typically 20-35% for private company minority interests.

DLOC (Discount for Lack of Control): A reduction in value for minority interests that cannot influence company decisions. Converts control value to minority value.

Conglomerate Discount: The amount by which a diversified company trades below the sum of its parts. Typically 10-30% due to complexity and management inefficiency concerns.

Treasury Stock Method (TSM): Method to calculate diluted shares outstanding. Assumes in-the-money options are exercised and proceeds used to repurchase shares at current market price.

Valuation Approaches

Comparable Company Analysis (Comps): Relative valuation using trading multiples of similar public companies. Produces minority, marketable value.

Precedent Transaction Analysis: Relative valuation using multiples paid in M&A transactions. Includes control premium; produces control, marketable value. Use transactions from past 3 years for relevance.

SOTP (Sum of the Parts): Valuation method for conglomerates that values each business segment separately using appropriate multiples, then sums results and subtracts net debt.

Residual Income Model: Valuation based on earnings above required return on equity capital. RI = Net Income - (Equity x Cost of Equity). Useful when dividends are unpredictable.

EVA (Economic Value Added): Profit above cost of all capital. EVA = NOPAT - (Invested Capital x WACC). Positive EVA indicates value creation; negative EVA indicates value destruction.

Reverse DCF: A DCF approach that starts with current market price and solves for the implied growth rate. Reveals market's embedded expectations.

Monte Carlo Simulation: Probabilistic valuation running thousands of iterations with variable distributions to produce a range of outcomes rather than a point estimate.

Cross-References

For detailed application of these terms, see:

• Checking Results Against Market-Implied Expectations (reverse DCF)
• Common Pitfalls in DIY Valuation Models (DCF errors)
• Documenting Valuation Assumptions Clearly (assumption documentation)
• Calibrating Target Prices with Risk/Reward (position sizing)

Updates

This glossary is updated to incorporate new valuation developments and refine definitions based on practitioner feedback.