2.2.8 · 40–60 minutes · read, calculate, discuss, review
What you will learn
- Compare relative, DCF and SOTP estimates on the same share basis.
- Defend a conditional recommendation to a committee.
- Identify evidence priorities and changes of mind.
2.2 · Valuation
Valuation
Valuation · the work you will do
- 1Define the cash flow
- 2Make assumptions explicit
- 3Estimate a range
- 4Compare with price
Before you begin
Harbour trades at £8. The base DCF is £8.39, comparable range £8.45–£10.55 and base SOTP £9.80. Is it enough to average them and announce a buy?
Write your first response before continuing.
Video coming soon · about 3 minutes
Bringing Valuation Together
Use the narration below while the recording is being made, then try the decisions in this lesson.
Read the full narration
Welcome to On Judgement. Harbour trades at £8. The base DCF is £8.39, comparable range £8.45–£10.55 and base SOTP £9.80. Is it enough to average them and announce a buy? Take a first view. You can change it when you have considered the evidence.
Display all methods on a common per-share basis, date, currency and share count. Harbour’s relative range is £8.45–£10.55, DCF sensitivity range £6.60–£11.36 and SOTP range £8.70–£10.90. A football-field comparison shows overlap and disagreement. It is not a probability chart, and a historical trading high or low is not an independent estimate of intrinsic value.
DCF depends on reinvestment, cash timing, long-run growth and discount rate. Multiples depend on peer selection, earnings quality and current pricing. SOTP depends on divisional estimates and corporate adjustments. The methods may share the same optimistic operating forecast, so they are not necessarily independent confirmations. Weight the evidence according to relevance and reliability rather than automatically weighting three outputs equally.
Explain the business, current financial quality, estimated value, risks and what the price seems to assume. Include the strongest counterargument. A conclusion may be investigate, defer, reject or a conditional hypothetical investment; no real trade is required. Any proposed position size needs a separate portfolio mandate and risk context, not an arbitrary percentage attached to a valuation gap.
A portfolio-manager roleplay should challenge cash conversion, peer quality, terminal dependence, debt and the competitive case. Answer with a source, calculation or explicit unknown. Keep the original decision record and any revisions. Later price moves are evidence to review, not the only test of decision quality. This prepares the investment case in Section 3 and the eventual pitch in Futures.
Let's work through What does the apparent upside establish?. Use observed price £8, base DCF £8.38843, relative midpoint £9.50 and base SOTP £9.80. Compare implied price gaps before distributions, costs or timing. Pause here and try the calculation or reasoning before continuing.
Base DCF gap = (8.38843/8 − 1) × 100 = 4.86%, approximately. Relative midpoint gap = (9.50/8 − 1) × 100 = 18.75%. Base SOTP gap = (9.80/8 − 1) × 100 = 22.5%. DCF low cell £6.60 lies below current price by about 17.5%, using rounded values.
These are conditional valuation-to-price gaps, not expected annual returns. No timing, probability, dividend path or convergence guarantee has been supplied.
Now try the choices in this lesson. If your answer changes, identify the reason. Identify evidence priorities and changes of mind. Use the case activities to put the idea into your own words, and return to the evidence when more than one conclusion is defensible.
Make the ranges comparable
Display all methods on a common per-share basis, date, currency and share count. Harbour’s relative range is £8.45–£10.55, DCF sensitivity range £6.60–£11.36 and SOTP range £8.70–£10.90. A football-field comparison shows overlap and disagreement. It is not a probability chart, and a historical trading high or low is not an independent estimate of intrinsic value.
Investigate why methods differ
DCF depends on reinvestment, cash timing, long-run growth and discount rate. Multiples depend on peer selection, earnings quality and current pricing. SOTP depends on divisional estimates and corporate adjustments. The methods may share the same optimistic operating forecast, so they are not necessarily independent confirmations. Weight the evidence according to relevance and reliability rather than automatically weighting three outputs equally.
Prepare the investment case
Explain the business, current financial quality, estimated value, risks and what the price seems to assume. Include the strongest counterargument. A conclusion may be investigate, defer, reject or a conditional hypothetical investment; no real trade is required. Any proposed position size needs a separate portfolio mandate and risk context, not an arbitrary percentage attached to a valuation gap.
Face the committee
A portfolio-manager roleplay should challenge cash conversion, peer quality, terminal dependence, debt and the competitive case. Answer with a source, calculation or explicit unknown. Keep the original decision record and any revisions. Later price moves are evidence to review, not the only test of decision quality. This prepares the investment case in Section 3 and the eventual pitch in Futures.
What does the apparent upside establish?
Three methods do not produce certainty
Which differences arise from method, and which from the assumptions used?
Use observed price £8, base DCF £8.38843, relative midpoint £9.50 and base SOTP £9.80. Compare implied price gaps before distributions, costs or timing.
- Base DCF gap = (8.38843/8 − 1) × 100 = 4.86%, approximately.
- Relative midpoint gap = (9.50/8 − 1) × 100 = 18.75%.
- Base SOTP gap = (9.80/8 − 1) × 100 = 22.5%.
- DCF low cell £6.60 lies below current price by about 17.5%, using rounded values.
These are conditional valuation-to-price gaps, not expected annual returns. No timing, probability, dividend path or convergence guarantee has been supplied.
Common £-per-share scale, £6–£12. Labels give exact rounded endpoints; bars illustrate conditional estimates.
Relative
£8.45–£10.55
£8.45–£10.55
DCF sensitivity
£6.60–£11.36
£6.60–£11.36
SOTP
£8.70–£10.90
£8.70–£10.90
Observed price: £8.00. Base DCF: £8.39. Base SOTP: £9.80.
Put it into practice
1. Build the football field
Draw the three ranges, mark £8 and the DCF/base SOTP estimates, and explain which assumptions you trust most.
Record your response in your workbook before opening feedback.
Compare with a model response
Use a consistent horizontal £-per-share scale. Label relative 8.45–10.55, DCF 6.60–11.36 and SOTP 8.70–10.90. Justify weighting using peer economics, cash forecasts and corporate adjustments.
2. Run the committee
In pairs, challenge the analyst on terminal value, cash conversion and one competitor risk. The analyst must identify one unresolved question.
Record your response in your workbook before opening feedback.
Compare with a model response
Ask why 81.6% of DCF EV comes from terminal PV, whether capex and working capital are sufficient, and whether the chosen peers face similar risks. Honest uncertainty with a next step is preferable to invented precision.
3. Write the decision
Prepare a 300–450 word investment note with two numerical exhibits, a counterargument and two evidence-based review triggers.
Record your response in your workbook before opening feedback.
Compare with a model response
A defensible note can defer until customer/capex evidence improves, or support a conditional view. It should acknowledge base DCF’s small gap, downside cells, peer limitations and why SOTP is not guaranteed proceeds. Assessment rewards reasoning, not a prescribed buy.
Jargon buster
Football field
A common-scale comparison of valuation ranges.
Valuation gap
A stated difference between estimated value and observed price.
Margin of safety
A proposed buffer for uncertainty, requiring judgement rather than a universal rule.
Investment case
An evidence-based argument connecting business, price, risk and decision.
Counterargument
The strongest credible challenge to the proposed conclusion.
Decision record
A retained account of evidence, assumptions and reasoning at the time.
Knowledge check
Make each choice on the page. Feedback explains the reasoning. Use Try again after revisiting an idea.
AQA connection and further reading
AQA 7138 connections: 3.1.4 financial management, 3.3.3 strategy/investment appraisal, 3.3.4 change and uncertainty; Annex 6 quantitative interpretation; AO2–AO4 application, analysis and evaluation. Enterprise DCF, WACC, trading multiples and SOTP are investing enrichment, not prescribed AQA company-valuation methods.
AQA 7138 specification
Primary curriculum mapping; teacher interpretation, not endorsement.
IAS 7 overview · IFRS Foundation
Accounting classification context. Presentation changes and effective/adoption dates must be checked for real reports.
Free Cash Flow Valuation · CFA Institute
Technical cross-check for consistent claims and valuation formulas; advanced optional reading.
Introduction to Valuation · Aswath Damodaran, NYU
Optional deeper reading on valuation approaches.
Take forward
Compare relative, DCF and SOTP estimates on the same share basis. Defend a conditional recommendation to a committee. Identify evidence priorities and changes of mind.