Intrinsic vs Relative Valuation Explained
Valuation interviews often test whether you understand not just how to calculate value, but how to think about value. Intrinsic valuation is the fundamentals-led anchor, while relative valuation is the market-pricing cross-check. This matters because investment bankers typically use both in a valuation football field rather than relying on one definitive number.
- Intrinsic Valuation (DCF) values a company based on fundamental cash flows.
- Relative Valuation (Comparables) values a company based on market pricing of peers.
- Intrinsic valuation methods include DCF, DDM, and Residual Income.
- Relative valuation methods include EV/EBITDA, P/E, P/B, and EV/Revenue comps.
- DCF is theoretically rigorous and not market-sentiment driven, but highly sensitive to assumptions such as WACC and growth.
- Comparables are simple, market-based, and widely understood, but only as good as the comp set and can inherit mispricing.
- In practice, investment bankers use a valuation football field - no single method is definitive.
The Big Picture
Intrinsic valuation and relative valuation answer the same question from different directions. The DCF anchors fundamental value while trading and transaction comps provide market context.
In Indian usage, relative valuation is used in IPO pricing. Paytm used EV/Rev; Nykaa used P/GMV. The strategic so what is that IPO pricing, quick screening, and market sentiment usually need market-benchmarked valuation context.
DCF Intrinsic Value: V = ฮฃ FCF_t/(1+WACC)^t + TV/(1+WACC)^n. TV = Terminal Value (Gordon Growth or Exit Multiple).
Intrinsic Valuation as the Fundamentals-Led Anchor
Intrinsic Valuation (DCF) uses value based on fundamental cash flows. Its methods include DCF, DDM, and Residual Income. DDM means Dividend Discount Model.
It is used for long-term value investing, M&A, and fairness opinion. Its key advantage is that it is theoretically rigorous and not market-sentiment driven.
The main disadvantage is that it is highly sensitive to assumptions, especially WACC and growth. WACC is calculated as WACC = KeยทE/(D+E) + Kd(1โt)ยทD/(D+E), where Ke = cost of equity; Kd = pre-tax debt cost; t = tax rate.
Intrinsic valuation is best for companies with predictable FCF, especially mature and stable companies. In Indian usage, it appears in IB DCF models and PE buyout models.
Relative Valuation as the Market-Pricing Cross-Check
Relative Valuation (Comparables) uses value based on market pricing of peers. Its methods include EV/EBITDA, P/E, P/B, and EV/Revenue comps.
It is used for IPO pricing, quick screening, and market sentiment. Its advantages are that it is simple, market-based, and widely understood.
The main disadvantage is that it is only as good as the comp set and inherits mispricing. It is best for companies with many listed peers, including consumer and IT companies.
Why Bankers Use Both
In practice, investment bankers use a valuation football field - showing the range of values from multiple methods. No single method is definitive.
The DCF anchors fundamental value while trading and transaction comps provide market context. Analysts present a valuation range, not a single number.
Structuring a Intrinsic vs Relative Valuation Explained Interview Answer
"How would you explain intrinsic valuation versus relative valuation, and why do bankers use both?"
The strongest answer does not claim one method is always correct. Say that the DCF anchors fundamental value while trading and transaction comps provide market context.
The most frequent error is treating one valuation method as definitive. This costs points because in practice, investment bankers use a valuation football field - showing the range of values from multiple methods.
Conclusion
Intrinsic valuation and relative valuation are complementary, not competing. The DCF anchors fundamental value, while comparables provide market context, and the practical answer is to present a valuation range rather than a single number.