How to Select the Optimal Valuation Method to Build Better Price Targets (Part 3 of 3)

This 3-part post is all about following best practices for selecting the optimal valuation method…namely the one that’s going to derive a price target more accurate than consensus.

As noted in Part 2 of this 3-part series, there are limitations to every valuation method, but some are better than others. For years I had been looking for an information source that quickly summarized the best method(s) to use under each circumstance, but couldn’t find one. So I created the flow chart below.

The idea is to start at the top of the flow chart and work your way down as far as possible, to get closer to the methods that measure free cash flow. Note the blue shapes are single-period multiples-based methods whereas the tan shape, DCF, is a multi-period cash flow method.

Callout: The further you can go through the flowchart, the closer you are to valuing the company’s free cash flows.

 

©AnalystSolutions LLC All rights reserved. James J. Valentine, CFA is author of Best Practices for Equity Research Analysts, founder of AnalystSolutions and was a top-ranked equity research analyst for ten consecutive years.