Definition

Price to DFCF Terminal Value is a valuation metric that compares the current market price of a company to the terminal value derived from the Discounted Free Cash Flow (DFCF) model. The terminal value represents the present value of all future cash flows of a company beyond a certain forecast period, often calculated using a perpetuity growth model or an exit multiple approach.

Formula

Price to DFCF Terminal Value = Current Market Price / Terminal Value from DFCF

How to use the valuation method

To use this valuation method, first calculate the terminal value of a company using the DFCF model. This involves forecasting the company's free cash flows for a specific period and then estimating the terminal value using either the perpetuity growth model or an exit multiple. Once the terminal value is determined, divide the current market price of the company by this terminal value to get the Price to DFCF Terminal Value ratio. This ratio can be used to assess whether a company is overvalued or undervalued compared to its future cash flow potential.

Which industries it work best in

This valuation method works best in industries with stable and predictable cash flows, such as utilities, consumer staples, and mature technology companies. These industries often have less volatile cash flows, making it easier to forecast future performance and calculate a reliable terminal value.

Which industries it does not apply to and why

The method does not apply well to industries with highly volatile or unpredictable cash flows, such as startups, biotechnology, or cyclical industries like commodities. The uncertainty in cash flow projections makes it difficult to accurately estimate the terminal value, leading to potentially misleading valuation results.

Summary

Price to DFCF Terminal Value is a useful metric for evaluating a company's market price relative to its future cash flow potential, particularly in industries with stable cash flows. However, it may not be suitable for industries with high cash flow volatility or uncertainty.