All valuation models

Stock analysis model

Discounted Cash Flow (DCF) Model

The Discounted Cash Flow model estimates a company's intrinsic value by forecasting future free cash flows and discounting them to their present value. It is one of the most widely used fundamental valuation methods.

When DCF is useful

  • Companies with reasonably predictable and positive free cash flow.
  • Long-term investors who want an intrinsic value estimate instead of relying only on market multiples.
  • Testing how growth, margins and discount rates affect a valuation.

Limitations to consider

  • Small changes in growth, WACC or terminal assumptions can materially change the result.
  • Young, cyclical or unprofitable businesses are difficult to forecast reliably.
  • A DCF should be used as a valuation range rather than a precise price target.

How the model works

  1. 1Collect free cash flow, debt, cash, shares outstanding and other relevant financial data.
  2. 2Forecast future free cash flows over a defined projection period.
  3. 3Estimate a suitable discount rate, commonly the weighted average cost of capital.
  4. 4Calculate terminal value for cash flows beyond the explicit forecast period.
  5. 5Discount projected cash flows and terminal value back to today.
  6. 6Adjust enterprise value for debt and cash, then divide by shares outstanding.

How to interpret the result

Compare the estimated intrinsic value per share with the current market price. A market price below the estimate may indicate undervaluation, while a price above it may indicate overvaluation. Because assumptions are uncertain, scenario and sensitivity analysis are essential.

Frequently asked questions

What does DCF stand for?

DCF stands for Discounted Cash Flow. The method values a business based on the present value of its expected future cash flows.

Is DCF accurate?

A DCF can be useful when assumptions are realistic, but it is highly sensitive to forecasts, discount rates and terminal value. It is best treated as a range rather than an exact answer.

What is WACC in a DCF model?

WACC is the weighted average cost of capital. It represents the blended required return of a company's debt and equity investors and is commonly used as the discount rate.

Learn the method in context

Go beyond the score with worked explanations, assumptions and common mistakes in the Stock Insights Academy.

Read the related Academy guide

Apply DCF to a stock

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