Damodaran on Valuation

7.2. UBIQUITY OF RELATIVE VALUATION

Notwithstanding the focus on discounted cash flow valuation in classrooms and in theory, there is evidence that most assets are valued on a relative basis. In fact, consider the following:

• Most equity research reports are based on multiples: price-earnings ratios, enterprise value-to-EBITDA ratios, and price-to-sales ratios are but a few examples. In an informal study of 550 equity research reports in early 2001, relative valuations outnumbered discounted valuations almost 10 to 1.^[] While many equity research reports included the obligatory cash flow tables, values were estimated and recommendations were made by looking at comparable firms and using multiples. Thus, when analysts contend that a stock is under- or overvalued, they are usually making that judgment based on a relative valuation.

  ^[] I did the study, which included sell-side equity research reports from different investment banks in the United States, London, and Asia. About 75 percent were from the United States, about 15 percent from Europe, and 10 percent from Asia.

• Discounted cash flow techniques are more common in acquisitions and corporate finance. While casual empiricism suggests that almost every acquisition is backed up by a discounted cash flow valuation, the value paid in the acquisition is often determined using a multiple. In acquisition valuation, many discounted cash flow valuations are themselves relative valuations in disguise because the terminal values are computed ...