Why might an investor use a peer comparison alongside DCF?

An investor might use a peer comparison alongside a discounted cash flow (DCF) analysis primarily to validate assumptions and valuation outcomes through external benchmarks. In the valuation process, particularly with DCF, the outcome can be highly sensitive to the assumptions made regarding growth rates, discount rates, and other critical inputs. By comparing these assumptions and resultant valuations against those of similar companies (peers) in the same industry, an investor can gain insights into whether their expectations are reasonable and grounded in the current market environment.

Utilizing peer comparisons helps to provide a context for the DCF output, ensuring that the estimates are aligned with market realities. It allows the investor to assess whether the DCF-produced valuation appears justified when compared to the trading multiples or valuations of comparable firms. If the DCF result is significantly higher or lower than peer valuations, it might prompt a re-evaluation of key input assumptions used in the DCF model to ensure they reflect the broader market perspective. This practice enhances the credibility of the valuation analysis by incorporating external validation, leading to a more informed investment decision.