What Is Discounted Cash Flow?
Discounted cash flow, or DCF, is a way to value a company by estimating all the cash it will make in the future and working out what that cash is worth today.
Why future money is worth less
$100 today is worth more than $100 in ten years. You could invest today's $100 and have more later. So future cash is "discounted" back to today's value. If you could earn 8% a year, $100 in one year is worth about $93 today.
How a DCF works
- Estimate the free cash flow for the next 5 to 10 years.
- Estimate a value for all the years after that.
- Discount each year back to today using a chosen rate.
- Add it all up. That is the estimated intrinsic value.
The big weakness
Small changes in your guesses make huge changes in the answer. Add one point to the growth rate or take one off the discount rate, and the value can jump a lot. A DCF is a tool for thinking, not a precise answer.
See it in real companies
Open a company to see what it sells and how it makes money.
Related terms
Intrinsic valueWhat a business is really worth.
Free cash flowReal cash left after running and growing the business.
Margin of safetyBuying well below what you think it is worth.
Interest ratesThe price of borrowing money.
Value investingBuying good companies for less than they are worth.
CAGRThe average yearly growth rate over many years.