Valuation methods
Three broad approaches, none of them precise. The value of doing one properly is mostly in what it forces you to state out loud.
There are three families of approach, and each answers a slightly different question.
1. Multiples — what are similar things priced at?
Take a profit or revenue figure and multiply it by whatever the market pays for comparable businesses. The price-to-earnings ratio is the most common example.
Fast, widely used, and circular: it tells you what a company is worth if the comparison set is fairly priced. During a bubble, every company looks reasonably valued against its equally inflated peers.
2. Discounted cash flow — what is the future worth today?
Estimate the cash the business will produce for years ahead, then reduce each future year to a present value, because money later is worth less than money now. Sum the result.
The output is extraordinarily sensitive to two inputs nobody knows: the growth rate and the discount rate. Small, defensible changes to either move the answer by large amounts. Its real value is that it forces you to write down what you are assuming.
Which is why the most useful way to run one is backwards. Rather than producing a value and comparing it to the price, take the price the market is charging and solve for the growth rate that would justify it. Then ask whether that growth rate is plausible.
3. Asset-based — what would the pieces fetch?
Value what the company owns, subtract what it owes. Useful for businesses whose worth really is their assets — property, investment vehicles, companies in wind-down. Close to useless for a business whose value is a brand or a workforce.
What all three have in common
Even a multiple does, since the comparison companies are priced on expectations about their futures. There is no method that removes the need to guess; there are only methods that are more or less honest about where the guess sits.