Lesson 4 of 8
DCF: Discounted Cash Flow
A company is worth the cash it will generate, discounted to today
Estimate the company's future free cash flows for 5-10 years
Estimate a 'terminal value' for everything after that
Discount all future cash flows back to today's dollars using a rate (usually 8-12%)
Sum it all up. That's the intrinsic value.
If the stock price is below your DCF value, it might be undervalued.
A dollar tomorrow is worth less than a dollar today. DCF puts a precise number on that. The higher the discount rate, the less future cash flows are worth today.
Typical discount rate
8-12%
WACC
Small change in growth
Huge change
in valuation
Used by
Every bank
for M&A and IPO pricing
When DCF works vs. when it breaks
Coca-Cola
Predictable cash flows, slow growth, mature. Textbook DCF candidate.
Microsoft
Stable cash engine, but cloud growth rate assumption dominates the answer.
Tesla
Cyclical, capex-heavy, huge growth dispersion. DCFs are all over the place.
Palantir
Too much of the value sits in terminal multiples. The model becomes a vibes check.
Rule of thumb: if more than 60% of your DCF value is "terminal value," you're not valuing the business, you're guessing at its exit multiple.
reality check
DCF is powerful but fragile. Change the growth rate by 1% and the output changes by 20%+. Garbage in, garbage out. It's a framework for thinking, not a crystal ball.
Check yourself
In a DCF model, what does a higher discount rate do to the valuation?