Common pitfalls

Valuation models project confidence, but a clean spreadsheet hides where the real risks live. These are the mistakes that wreck more analyses than any other.

Garbage in, garbage out

A DCF is only as good as its inputs. Tiny changes to the growth rate or discount rate swing the output enormously. The danger is false precision — a model that outputs 15.89 per share looks authoritative, but if the growth assumption was a guess, so is the answer. Always test how the value moves when you change the key inputs (this is sensitivity analysis), and quote a range, not a single number.

Terminal-value sensitivity

Recall that in our DCF the terminal value was 1,334 of an enterprise value of 1,789 — about 75%. So most of the valuation rests on a guess about cash flows beyond year 5. Change the perpetual growth from 3% to 4% and the terminal value jumps sharply:

g = 3%:  146 x 1.03 / (0.10 - 0.03) = 2,149
g = 4%:  146 x 1.04 / (0.10 - 0.04) = 2,531

A single percentage point lifted the terminal value by nearly 18%. Keep the perpetual growth rate conservative — never above long-run economic growth — and always show the range.

Other traps

• Anchoring to the current price. Build the value independently, then compare; do not reverse-engineer a model to justify today's quote.
• Ignoring debt. A low P/E on a company buried in debt is not cheap — it is risky. Always read equity multiples against the balance sheet.
• Extrapolating a good year forever. One strong quarter is not a trend. Use normalized, mid-cycle figures.
• Trusting accounting profit over cash. A profit that never converts to free cash flow is the most common prelude to a blow-up.

The model is a tool for thinking, not an oracle. Treat its output with healthy suspicion.