What is DCF value?

Discounted cash flow (DCF) valuation estimates what a company is worth today from the cash it is expected to generate in the future.

How DCF works

A dollar today is worth more than a dollar a year from now, because today’s dollar can be invested and grow. At 5% interest, $10,000 today becomes $10,500 in a year.

DCF works the other way round. It forecasts the cash a company will generate and converts each future amount back into today’s money. This step is called discounting. Companies with high and stable cash flows are worth more than companies with low and volatile ones.

How Alpha Spread calculates DCF value

A DCF valuation needs two inputs: a forecast of the company’s free cash flow and a discount rate that reflects how risky that cash flow is.

Free cash flow forecast

Alpha Spread has several operating models and picks one for each company based on its characteristics. The forecast takes into account:

• Historical performance, with regression models that extend past trends.
• Industry base rates: how similar companies have performed in the past.
• Analyst estimates for the company and its industry.

Discount rate

Depending on the model, the discount rate is either the weighted average cost of capital (WACC) or the cost of equity. It reflects the risk-free rate, the company’s capital structure, its interest coverage and risk premiums. A riskier company gets a higher discount rate, which lowers its value.

Scenarios and your own model

The DCF Valuation tab of each stock shows a base, a bull and a bear scenario. You can change the model inputs there to see how the value responds to your own assumptions.