How Fair Value Estimation Works: PEG, DCF, and EV/EBITDA Explained

Fair value estimation is arguably the most important step in stock analysis. It answers the fundamental question: what is this business actually worth? At Convex, we use three independent valuation methods and blend them to produce a single, reliable fair value estimate.

Why Three Methods?

No single valuation method is perfect. Each has strengths and blind spots:

• PEG-based valuation works well for growth companies but can mislead for cyclicals
• FCF DCF (Discounted Cash Flow) is theoretically sound but sensitive to growth and discount rate assumptions
• EV/EBITDA is great for comparing companies but ignores capital structure differences

By blending all three, we reduce the impact of any single method's weaknesses and arrive at a more robust estimate.

Method 1: PEG-Based Valuation

The PEG ratio relates a stock's P/E ratio to its expected earnings growth rate. A PEG of 1.0 means you're paying fair value for the growth. Convex uses the PEG ratio to derive a target P/E, then multiplies by expected earnings to get a fair value price.

Key inputs: forward EPS, earnings growth rate (from our growth cascade), and classification-based PE caps to prevent unrealistic valuations.

Method 2: FCF DCF

The discounted cash flow model projects future free cash flows and discounts them back to present value using the company's WACC (Weighted Average Cost of Capital). Convex uses a Blume-adjusted beta for more stable discount rates and applies exit multiples for growth stocks instead of the traditional Gordon Growth Model.

Key inputs: trailing free cash flow, growth rate, WACC (bounded 6-20%), and a 10-year projection period.

Method 3: EV/EBITDA

Enterprise Value to EBITDA is one of the most widely used relative valuation metrics. It's capital-structure neutral and works well across industries. Convex compares the stock's current EV/EBITDA to historical and sector averages, with quality adjustments.

The Blending Process

The three valuations rarely agree exactly. Convex uses a weighted blend based on the stock's classification — compounders weight DCF more heavily, cyclicals weight EV/EBITDA, and growth stocks weight PEG. The blend also includes:

• Outlier detection — If one method diverges significantly from the others, it's weighted down
• Quality premium/discount — High-quality businesses get a premium (up to 15%), low-quality get a discount
• FV confidence score — Measures how much the methods agree (high agreement = higher confidence)

What the Number Means

The fair value estimate is our best assessment of what the stock is worth today, based on fundamentals. Compare it to the current market price:

• Price well below FV — Potential undervaluation (check the buy zones)
• Price near FV — Fairly valued, returns will come from business growth
• Price well above FV — Potential overvaluation, higher risk

Remember: fair value is an estimate, not a guarantee. Use it as one input in your broader analysis — which is exactly why Convex also provides scenario modeling, asymmetry analysis, and buy zones.