The DCF (Discounted Cash Flow) estimates a stock's intrinsic value by adding up its future cash flows, brought back to their value today. The core idea: a company is worth the sum of the money it will generate in the future, adjusted for the fact that a euro tomorrow is worth less than a euro today.
Why discount future flows?
A euro received in ten years is worth less than a euro today: it cannot be invested in the meantime, and inflation erodes its purchasing power. Discounting translates this principle by applying a rate that reduces the value of flows the further away they are. This rate also reflects risk: the riskier a company, the higher the return demanded, the harder the discounting.
What are the steps of a DCF?
A DCF is built in four logical steps.
The result is an estimate of the company's value, which is divided by the number of shares to obtain a per-share value to compare with the market price.
What is the terminal value?
The terminal value represents all flows beyond the explicitly projected period. It often accounts for the majority of the total valuation, which makes it both the most important and the most sensitive element. A small change in the perpetual growth rate or the discount rate changes the result considerably.
Why is the DCF so sensitive to assumptions?
The DCF is mathematically rigorous but rests on forecasts. Two analysts with slightly different growth and rate assumptions can arrive at very different valuations. This is the model's main criticism: "garbage in, garbage out." It is better to reason in a valuation range than in a single figure, and to test several scenarios.
How to use the DCF in practice?
The DCF serves less to obtain a precise price target than to measure a margin of safety: the gap between the estimated intrinsic value and the current price (the upside or downside). In InvestIQ, this DCF upside feeds the valuation cluster, which weighs about 12%. Valuation is treated there as a long-term risk/reward context, not as a timing signal: a stock can stay undervalued for a long time.
What limits should you know?
The DCF works poorly for unprofitable, highly cyclical or very uncertain companies, where future flows are too hard to project. For these cases, comparative multiples (EV/EBITDA, price/sales) are preferred. The DCF is a powerful tool in the hands of those who know its limits, misleading for those who take its result as a truth.
This is not investment advice.