DCF = Discounted Cash Flow

What is the DCF model

The DCF model (Discounted Cash Flow) is a company valuation method that is based on estimating future free cash flows and converting them into their present value using a discount rate.

The goal of the DCF model is to determine the intrinsic value of a company, i.e. an estimate of its true value independent of its current market price.

How the DCF model works

The idea is that the value of a company is the sum of all its future cash flows, discounted back to the present.

Simplified formula: Company value = ∑ (FCF in each year / (1 + r)ⁿ) + terminal value

where:

• FCF = free cash flows in each year
• r = discount rate (often based on WACC)
• n = year of the period
• terminal value = estimate of company value after the end of the projection (so-called terminal value)

Key inputs into the DCF model

1. Free cash flow projection – usually 5-10 years ahead.
2. Discount rate – reflects the riskiness of the investment and the required return.
3. Terminal value – based on the long-term growth of the company after the projection period ends.

Advantages of the DCF model

• Focuses on the fundamental value of the company.
• Not dependent on current market prices or investor mood.
• Allows analysis of various growth and risk scenarios.

Disadvantages of the DCF model

• Requires precise estimates of FCF and discount rate – small changes can significantly affect the result.
• Difficult to apply to companies without stable cash flows (e.g. start-ups).
• Assumes a relatively stable economic environment.

DCF model in practice

Example: If a company generates FCF of CZK 1 billion per year, growth of 5% per year is expected and the discount rate is 8%, the DCF model calculates the present value of these flows and compares it with market capitalisation. If the calculated value is higher than the market price, the stock may be undervalued.

The DCF model on the Stonkee platform

On Stonkee the DCF model is part of the valuation toolkit. The AI automatically computes a fair price based on the latest financial data and compares it with the stock's market price. Users can therefore immediately see whether the stock is overvalued or undervalued based on fundamental analysis.

Summary

The DCF model is a key method for estimating the true value of a company based on future cash flows. Although it requires good estimates and a sensitive handling of parameters, it is among the most widely used tools of professional investors.