What Is DCF Valuation? A Complete Guide for Stock Investors

Why DCF Matters

Discounted Cash Flow (DCF) is the gold standard of fundamental valuation. Unlike relative metrics (PE, PB), DCF values a company based on its future cash flows, discounted back to today's dollars. It answers the question: "What is this business actually worth?"

The DCF Formula

Enterprise Value = Σ (FCF_t / (1 + WACC)^t) + Terminal Value / (1 + WACC)^n

Where:

• FCF = Free Cash Flow (operating cash flow minus capital expenditure)
• WACC = Weighted Average Cost of Capital (your discount rate)
• Terminal Value = Value of all cash flows beyond your projection period

Step 1: Project Free Cash Flows (5 Years)

Start with the company's most recent financials:

Year	Revenue	Growth	EBIT Margin	FCF
Base	$30B	—	25%	$6B
Y1	$36B	20%	26%	$7.5B
Y2	$43B	19%	27%	$9.2B
Y3	$50B	16%	27%	$10.8B
Y4	$57B	14%	28%	$12.5B
Y5	$64B	12%	28%	$14.1B

Key assumptions to get right:

• Revenue growth rate (most impactful variable)
• Operating margin trajectory
• Capital expenditure as % of revenue
• Working capital changes

Step 2: Calculate WACC

WACC = (E/V × Re) + (D/V × Rd × (1-T))

For most equity analysis:

• Cost of equity (Re): Use CAPM = Risk-free rate + Beta × Equity risk premium
• Cost of debt (Rd): Company's average borrowing cost
• Tax rate (T): Effective corporate tax rate

Typical WACC range: 8-12% for most public companies.

Step 3: Calculate Terminal Value

Two methods:

Gordon Growth Model (preferred):

TV = FCF_final × (1 + g) / (WACC - g)

Where g = perpetual growth rate (typically 2-3%, matching long-term GDP growth).

Exit Multiple Method:

TV = EBITDA_final × Exit EV/EBITDA multiple

Step 4: Discount Everything Back

Sum up all discounted FCFs + discounted terminal value = Enterprise Value.

Subtract net debt, add cash = Equity Value.

Divide by shares outstanding = Intrinsic value per share.

Common Pitfalls

1. Overly optimistic growth assumptions — The most common mistake. Use industry benchmarks, not management guidance.
2. Terminal value dominates — If terminal value is >75% of total value, your near-term projections may be too conservative or your growth rate too high.
3. Ignoring sensitivity analysis — Always run bull/base/bear scenarios with different WACC and growth assumptions.
4. Using wrong FCF — Use unlevered FCF (before interest) for enterprise value, not net income.

Try It Yourself

DeepAngles can build a complete DCF model for any stock in minutes — including sensitivity analysis with adjustable WACC and growth rates.

Try DCF Valuation on DeepAngles →

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This guide is for educational purposes only and does not constitute investment advice.