1. Introduction to Discounted Cash Flow Analysis
  2. DCF Analysis: The Forecast Period & Forecasting Revenue Growth
  3. DCF Analysis: Forecasting Free Cash Flows
  4. DCF Analysis: Calculating the Discount Rate
  5. DCF Analysis: Coming Up with a Fair Value
  6. DCF Analysis: Pros & Cons of DCF
  7. DCF Analysis: Conclusion

Financial ratios and multiples – including metrics like debt-to-equity ratio, price-earnings ratio and return on equity – provide a quick way for investors to determine the general value of a stock compared to other investments in the market. If you want to estimate the absolute value of a company, however, discounted cash flow (DCF) analysis can come in handy. It takes into account the time value of money – the idea that the money that’s available today is worth more than the same amount in the future because of its potential earning capacity.

Finance professionals often use the discounted cash flow (DCF) valuation method to determine the attractiveness of an investment opportunity. DCF analysis uses future free cash flow (FCF) projections  and discounts them to estimate the present value, which is then used to evaluate the investment potential. In general, if DCF analysis indicates a value that is higher than the current cost of the investment, it signals a good opportunity. For example, if you estimate a stock is worth $50 based on your DCF analysis – and it’s currently trading at $30 – you know the stock is undervalued.

In simple terms, DCF analysis attempts to value a project, company or asset today, based on how much money it’s projected to make in the future, with the idea that the value is inherently contingent on its ability generate cash flows for investors.

There are several variations when it comes to DCF analysis, and each is based on multiple assumptions, such as the amount of future cash flows, timing of cash flow, cost of capital, growth rate. Even a small change in a single assumption can result in very different valuation results – which helps explain why market analysts often come up with varying price target estimates when placing a fair value on companies.

Here, we’ll focus on the free cash flow to equity approach to DCF analysis – the one that’s commonly used by Wall Street analysts to determine the fair value of companies. In this tutorial, we’ll guide you through DCF analysis with a step-by-step example using ACME Corp. – a hypothetical U.S.-based manufacturing company. We’ll start by looking at how to determine the forecast period for your analysis and how to forecast revenue growth.  


DCF Analysis: The Forecast Period & Forecasting Revenue Growth
Related Articles
  1. Trading

    Stock Analysis Basics: How To Forecast Revenue and Growth

    Forecasted revenue and growth projections are important components of security analysis, leading to a stock’s future worth.
  2. Investing

    Evaluate Stock Price With Reverse-Engineering DCF

    This is a more accurate method to use when trying to find a target price for a stock.
  3. Personal Finance

    Discounted cash flows or comparables: Which to use

    DCF and comparables models are widely used in equity valuation, and here we'll explain the pros and cons of each method.
  4. Investing

    Analyze Cash Flow The Easy Way

    Learn the key components of the cash flow statement and how to analyze and interpret changes in cash. Improving free cash flow means a company is in a better position to reward shareholders. ...
  5. Tech

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  6. Investing

    Corporate cash flow: Understanding the essentials

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself.
Frequently Asked Questions
  1. Why did the New York Stock Exchange report prices in fractions before it switched to decimal reporting?

    Before April 9, 2001, prices on the New York Stock Exchange were denominated in fractions - in one-sixteenths to be exact.
  2. Which Transactions Affect Retained Earnings?

    Retained earnings is the cumulative total of earnings or net income that have yet to be paid to shareholders. Retained earnings ...
  3. What is the difference between derivatives and options?

    A derivative is a financial contract that gets its value from an underlying asset. Options offer one type of common derivative.
  4. How can I calculate the delta adjusted notional value?

    Learn how to calculate the delta adjusted notional value of an options contract and why gross notional value cannot be used, ...
Trading Center