What a discounted cash flow valuation tells you
A business is worth the cash it will hand its owners over its lifetime, adjusted for the fact that a dollar later is worth less than a dollar today. A discounted cash flow (DCF) model projects that cash and discounts each year back to the present at your required return. The total is an estimate of intrinsic value. If it’s well above the share price, the stock may be cheap.
- The terminal value usually dominates. Most of a typical DCF’s value comes from cash flows beyond year 10. The split bar shows how much of your answer rests on that “forever” assumption.
- Small changes swing the answer. Moving the discount rate by one point can shift the value 15–25%. Treat the result as a range, and buy with a margin of safety.
- Reverse DCF. Enter the current price as the intrinsic value and leave growth blank. The result is the growth the market is already pricing in, which is often a more useful question than “what is it worth?”
The DCF formula
Value = Σ CF₀(1 + g)t ÷ (1 + r)t + [CFN(1 + gT) ÷ (r − gT)] ÷ (1 + r)N
CF₀ is today’s free cash flow per share, g the growth rate for N years, gT the terminal growth rate and r the discount rate. Growth, discount and terminal rates are solved by bisection. See the methodology.