DCF Model
In short
Discounted Cash Flow — estimates a stock's value from projected future cash flows
Imagine a friend promises to pay you $100/year for 10 years. Would you pay $1,000 today? Not quite — money tomorrow is worth less than money today. DCF calculates what future cash flows are worth right now.
DCF projects a company's free cash flows into the future, then discounts them back to present value using WACC. It's the most theoretically sound valuation method but highly sensitive to growth and discount rate assumptions.
Formula
DCF = Σ (FCF_t ÷ (1 + WACC)^t) + Terminal ValueRelated concepts
- WACC — WACC is the average rate a company pays for all its funding — both equity (shareholders expect returns) and debt (banks charge interest). It's the minimum return a company must earn to create value.
- Terminal Value — In a DCF, you can't project cash flows forever. Terminal value captures everything after your forecast period (usually 5-10 years). It often accounts for 60-80% of total DCF value — so getting the growth rate right matters more than almost any other single input.
- Intrinsic Value — The market price is what people are willing to pay right now. Intrinsic value is an estimate of what the stock is actually worth based on the company's cash flows and assets. If a $40 stock has an estimated intrinsic value of $55, the gap ($15) is what practitioners call the margin of safety.
- FCF Margin — If a business earns $100 in sales and has $15 left after paying all its bills and investing in the equipment needed to keep running, its FCF margin is 15%. Cash is what actually funds dividends, buybacks, and debt paydown — accounting profit alone doesn't.