How it works
A discounted cash flow model prices a company by the cash it will generate. The engine projects free cash flow at your growth rate for the forecast period, discounts each year's cash back at the discount rate (the company's cost of capital), and adds a terminal value — the perpetuity the company is worth after the forecast window — also discounted back. The total enterprise value divided by shares outstanding is the intrinsic value per share. Compare that to the market price: if intrinsic exceeds price, the model says the stock is cheap. The honest caveat is that every input is an estimate, and small changes compound — raising growth from 8% to 10% or lowering the discount from 10% to 8% can move intrinsic value 30-50%. The engine keeps the terminal value visible because it typically dominates: most of a DCF's value lives in the perpetuity assumption, which is where arguments actually happen.
Formula
Intrinsic = Σ FCF(t)/(1+d)^t + Terminal/(1+d)^n, all divided by shares
Tips
- The discount rate is the risk statement — higher risk, higher discount, lower value.
- Cross-check against the P/E ratio calculator: DCF says what cash is worth; P/E says what the market pays.
- Stress-test growth and discount by 2 points each way before acting on the result.
- A stock priced at less than intrinsic by a wide margin is a candidate, not a certainty — margins of safety exist because estimates are wrong.
Frequently asked questions
- What is a DCF valuation?
- Discounted cash flow valuation projects a company's future free cash flow, discounts it back at a risk-adjusted rate, and adds the terminal value — giving a fair value for the whole company, which dividing by shares converts to a fair price per share. It is the fundamental investor's price tag for a business.
- What is terminal value?
- The value of the company beyond the forecast window, treated as a perpetual stream growing at a stable rate. Because it is discounted over many years it usually contributes 60-80% of the final value — the biggest lever in the model and the hardest to get right.
- What is a good discount rate?
- The weighted average cost of capital (WACC): roughly 8-12% for most businesses, higher for volatile ones and lower for stable cash cows. It represents the return investors demand for the risk — a 10% WACC means the model values a dollar of future cash at $0.91 today at year one.
- Why does my intrinsic value differ from the stock price?
- The market prices in its own growth, discount and terminal assumptions, plus sentiment. When the two disagree, one of you has different inputs — the practical response is to check which assumptions would justify the market price, not to declare the market wrong.