DCF Valuation Report
Valuations are the hallmark of going public. At Swordblade, we are proponents of the DCF method of valuing a company, due to the detailed information that it provides both directors and investors in the company. DCF, or Discounted Cash Flow, is a methodology that takes into account cashflow in order to evaluate current, and future valuations of a company. This analysis, and other methods, are all provided as a service here at Swordblade, and you can find our DCF calculator here, to get a basic understanding of how the calculation works in practice.
DCF method:
This method determines the value based on its return in the future – its future cash flows. By looking at future returns, a future valuation can be estimated. The main requirement for a company to use this model is for it to have predictable and positive cashflows, otherwise the model will not value the company in a particularly different way.
For a DCF calculation, a number of assumptions are made:
- The growth rate of cashflows in future years.
- The discount rate of the company to discount future cashflows.
- The terminal rate which is used to evaluate the final value of the DCF.
It is generally recommended to be reasonable and conservative in these estimations, as the relative value will be judged at the end of the process by investors and others looking at a company – and undervaluation is usually more attractive than overvaluation.
For example, N26 – a German online bank similar to Revolut, has a valuation of €2bn from their DCF valuation, whilst maintaining an annual profit of €45 million euros. Such a huge valuation is derived from the DCF valuation over time, with a healthy market growth rate of around 55% estimated up to 2024. N26 demonstrates how bespoke the DCF methodology can be for each client and business. More information and the N26 DCF approach can be found here.
Why is a DCF valuation useful?
A significant number of clients already have their own auditor who gives them an initial value, but cannot always evaluate fair market value accurately due to the acutely involved nature of internal audit.
A DCF calculation is then usually completed via an outside source, such as Swordblade, as this form of valuation is usually required for stock exchanges and other markets used to acquire financing. This is because investors need to understand how companies got to their current stage, to make an informed decision on whether to invest or not.
A DCF valuation is particularly useful for third parties to understand, for investors to rely on its findings to provide a relative projection on the potential future value of companies that are difficult to evaluate individually.
For the company in question, a DCF valuation can prove to be very useful. The evaluation itself brings with it, for those companies with a positive cashflow, a high valuation. This is particularly important due to the current low interest rates from central banks worldwide. The interest rates mean that any company that is making a return above these rates (0.1% in the UK in 2021), the DCF valuation will be high.
DCF Pros and Cons:
- A highly detailed model that can be performed in excel.
- Inclusion of major assumptions about the business or model.
- Includes and builds in different scenarios, including those around future expectations of the business.
- DCF can be used to calculate the internal rate of return of a business, for use internally or by investors.
- Fundamentally determines the ‘intrinsic’ value of a company.
- Can create errors and overconfidence in the company’s valuation, if done incorrectly.
- Can be overcomplex and difficult for some investors to understand. DCF’s usefulness depends on the market of investors a company is aiming towards.
- DCF is very sensitive to any changes in assumptions, and requires a large number of assumptions initially.
- Terminal value is hard to estimate through DCF.
- DCF looks at company valuation in isolation and does not take into account relative valuations of competitors – though this depends on both industry and the size of the company.
Evaluation report on Valuations:
Swordblade offers a valuation report for companies, which does come at an increased cost, in order to understand business fundamentals and calculate a more exact valuation for clients to then begin moving forward with their strategic business aims.
Typically, a valuation report is needed for investors, to have confidence in the company and the investments that they are making. Swordblade offers this service via the Boston (US) based company, Cambridge Corporate Finance. Within this service, Swordblade provides a professional valuation report which includes the DCF valuation, and others depending on a client’s needs, explaining how the overall valuation was met with analytics and great detail.
Different Valuation Types:
Times Revenue Method.
A stream of revenues over a certain period are applied to a certain multiplier, depending on the industry. Too rigid for true accuracy over time.
Market Capitalization.
Calculated from existing shares – not useful to a newer, private, small cap company.
Earnings Multiplier.
This method adjusts a company’s P/E ratio to current interest rates. More useful but not accurate for the future or if a company doesn’t know its current share price.
Liquidation Value.
The net cash sum a company would receive on liquidation, usually best reserved for businesses in industries with major assets, i.e., Property businesses rather than IT services.
Dividend Discount Model.
A calculation is done based on dividend payments made to shareholders to understand value. This is because the dividend represents the actual cashflow to investors. This is only useful; A. If a dividend is present, and B. If the company’s dividend is stable and regular.
The Gordon Growth Model is a variant of this model, which is particularly useful for Blue Chip stocks.
Next Steps
If your company is planning to go public and raise funds on the capital markets, we look forward to hearing from you.
The easiest way to get started is to request a free evaluation. By providing minimal information about your company and capital needs, we will be able to provide you with a quick assessment by email. In most cases we can tell you if your business is ready to go public, or not yet.
We’ll also let you know if we think that Swordblade & Co are a good fit for your flotation plans, and anything else that we may think can help you.
Alternatively, if you are ready to talk in depth about floating your company, we recommend you arrange a paid consultation with one of our partners. It can usually be scheduled within a few days and is the fastest way to get detailed advice.
