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27 - How to calculate Intrinsic Value using Discounted Cash Flows (DCF)
Episode 27

27 - How to calculate Intrinsic Value using Discounted Cash Flows (DCF)

The DIY Investing Podcast · Trey Henninger: Private Investor, Portfolio Manager, Business Strategist, and Value Investing Expert

May 19, 201929m 56s

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How to calculate Intrinsic Value using Discounted Cash Flows (DCF) - Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode27

What is Intrinsic Value?
  • The present value of all future free cash flows produced by a business.
Time Value of Money
  • Cash today is worth more than cash in the future.
  • Therefore, you need to discount future cash flows to be worth less than their stated value.
The simplified discounted cash flow formula
  • Intrinsic Value = Owner's Earnings/(Discount Rate - Growth Rate)
    • Discount Rates: 10% (nominal) or 6.5% (real)
    • Growth Rates: Bounded between 0% and 5%
    • Owner's Earnings: Manually calculated by adjusting Net Income
Complex Discounted Cash Flow Calculations
  • When to use:
    • Company is in a high-growth phase of its business (has not yet saturated the market)
    • You are highly confident in short-term projections and the business is predictable
    • Reported earnings have a lot of temporary adjustments that make the next few years not match the long-term
  • When not to use:
    • Almost always
    • Why?
      • Complex calculations can trick you into thinking you have a better understanding of the business than you do
      • You'll likely rely heavily on growth and fast growth assumptions are very risky to make
References:
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