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About
Discounted Cash Flow (DCF) is a valuation metric used by investors (one of the sources of capital for a large business) to gauge the attractiveness of an investment opportunity. Most people accept that money loses value over time, which is a particularly important consideration for value investors who buy and hold: it's a fact that next year's $100 will be worth less than this year's $100. The value investor will apply a DCF analysis to projected cash flows (perhaps over 5 years or more) to arrive at the net current worth of those projected cash flows.
Valuation methods based on discounted cash flow models determine stock prices in a different and more robust way. DCF models estimate what the entire company is worth. Comparing this estimate, or "intrinsic value," with the stock's current market price allows for much more of an apples-to-apples comparison. For example, if you estimate that a stock is worth £20 based on a DCF model, and it is currently trading at £10, you know it's undervalued.
Estimating a stock's fair value or intrinsic value is no easy task. In fact, it is quite complex, involving all kinds of variables that are themselves tough to estimate. Despite their complexity, valuations based on DCF models are much more flexible than any individual ratio, and they allow an investor to incorporate assumptions about such factors as a company's growth prospects, whether its profit margins are likely to expand or contract, and how risky the company is in general.
Valuation methods based on discounted cash flow models determine stock prices in a different and more robust way. DCF models estimate what the entire company is worth. Comparing this estimate, or "intrinsic value," with the stock's current market price allows for much more of an apples-to-apples comparison. For example, if you estimate that a stock is worth £20 based on a DCF model, and it is currently trading at £10, you know it's undervalued.
Estimating a stock's fair value or intrinsic value is no easy task. In fact, it is quite complex, involving all kinds of variables that are themselves tough to estimate. Despite their complexity, valuations based on DCF models are much more flexible than any individual ratio, and they allow an investor to incorporate assumptions about such factors as a company's growth prospects, whether its profit margins are likely to expand or contract, and how risky the company is in general.