According to DCF methodology, what should not exceed 50% of the company's total implied value?

In Discounted Cash Flow (DCF) analysis, the terminal value represents the cash flows expected to be generated by the company beyond the explicit forecast period, typically calculated using either the perpetuity growth model or the exit multiple method. It is crucial to understand that the terminal value can often account for a substantial portion of the total implied value of a company, particularly when the forecast period is limited.

The guideline that terminal value should not exceed 50% of the total implied value comes from the principle that an excessive reliance on terminal value might indicate unrealistic assumptions about the company's future growth and stability. This serves as a risk management principle: if the terminal value represents too large a proportion, it suggests that the valuation may be overly optimistic or subject to significant uncertainty.

Maintaining terminal value below 50% of the total implied value encourages analysts to ensure that cash flows within the explicit forecast period are substantial enough to support the valuation, thereby enhancing the robustness of the DCF analysis. This balance helps in producing a more credible and viable valuation.

This understanding also reinforces the importance of grounding the DCF analysis in realistic assumptions related to cash flows and growth rates.