DCF
ValuationDefinition
Discounted Cash Flow. A method for figuring out what a business is worth today based on the cash it will generate in the future. Project the company's free cash flows for 5-10 years, estimate a long-term growth rate, then discount all those future cash flows back to today using the WACC. Add them up and you get the intrinsic value per share.
DCF is the theoretical gold standard of valuation. It is also a 'garbage in, garbage out' tool: a small change in the discount rate or growth assumption swings the answer by 50%. Used with a wide margin of safety rather than pinpoint precision.
DCF is the theoretical gold standard of valuation. It is also a 'garbage in, garbage out' tool: a small change in the discount rate or growth assumption swings the answer by 50%. Used with a wide margin of safety rather than pinpoint precision.
Formula
Value today = Sum of (Cash flow in year t divided by (1 + discount rate) to the power t) + Terminal value
Example
A company is projected to generate $100M of free cash flow next year, growing at 5%, with a discount rate of 10%. Rough DCF value = $100M divided by (10% minus 5%) = $2 billion.
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