The gold-standard valuation method — estimating what a company's future cash flows are worth in today's dollars.
A DCF (Discounted Cash Flow) model starts from a simple premise: a company is worth the sum of all the cash it will generate in the future — adjusted for the fact that future money is worth less than money today.
That second part — "adjusted for the fact that future money is worth less" — is the "discounted" part. If I offer you $100 today or $100 in 5 years, you'd obviously take the $100 today. You could invest it and have more than $100 in 5 years. The DCF model formalises this intuition.
DCF is considered the most theoretically rigorous valuation method because it connects price to fundamentals through a logical chain. Buffett, Munger, and most professional investors use DCF thinking — even informally — as the foundation of their valuation process.
Free cash flow = Operating Cash Flow − Capital Expenditure. This is the real cash the business generates after maintaining and growing its assets. Find it on the cash flow statement.
Estimate how fast free cash flow will grow each year. Base this on historical growth, analyst estimates, and your own view on the company's competitive position. Be conservative — optimistic projections are the #1 source of DCF errors.
Divide each year's projected FCF by (1 + discount rate)^year. The discount rate is typically WACC — the Weighted Average Cost of Capital, reflecting the risk of the business. A stable utility might use 7%; a high-growth tech company 12%.
Beyond year 10, you assume the business grows at a stable rate forever (usually 2–3%, near GDP growth). This 'terminal value' is discounted back to today and often represents 60–80% of the total DCF value — which is why it's so sensitive to your long-term growth assumption.
Let's value a hypothetical company with $100M in free cash flow this year, growing at 10%/yr for 5 years, then 3%/yr forever, using a 9% discount rate:
| Year | FCF ($M) | Discount factor (9%) | Present Value ($M) |
|---|---|---|---|
| 1 | 110 | 0.917 | 101 |
| 2 | 121 | 0.842 | 102 |
| 3 | 133 | 0.772 | 103 |
| 4 | 146 | 0.708 | 103 |
| 5 | 161 | 0.650 | 105 |
| Sum of 5-yr PV cash flows | $514M | ||
| Terminal value (PV) | $1,738M | ||
| Total intrinsic value | $2,252M | ||
If this company has 100M shares outstanding, the per-share intrinsic value would be $22.52. Compare that to the current stock price to assess whether the stock is cheap or expensive.
DCF is extremely sensitive to your assumptions — particularly the long-term growth rate and discount rate. Small changes produce large swings in the output:
This is why DCF should be one tool in your toolbox, not the only one. Always run a sensitivity analysis (test optimistic/pessimistic assumptions), and cross-check with P/E, Graham Number, and peer comparisons. BriMindInvest's Intrinsic Value tool runs DCF calculations automatically for you.
Why do we 'discount' future cash flows in a DCF model?
In a DCF model, a higher discount rate (WACC) results in:
A DCF model shows an intrinsic value of $95 per share for a stock currently priced at $70. The analyst used a 5% long-term growth assumption. What is the most prudent next step?
Our Intrinsic Value tool builds DCF models automatically using real financial data — so you can focus on interpreting the results rather than crunching numbers.