Discounted Cash Flow

Last modified 17:31, 1 Oct 2012

Discounted Cash Flow

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The Discounted Cash Flow model remains the most popular way to value a stock. One of the reasons for its popularity is its focus on cash flow which is a more reliable than using earnings which can be misleading.

ValueGain's discounted cash flow model is based on expected future cash flow and a discount rate. It is the foundation of most valuation models.

Time Value of Money

Financial theory says that the value of a stock is the present value of future cash flows.

The discounted cash flow model values a stock against expected future cash flow. The model is based on the Time Value of Money. Time value of money is the concept that $1000 today is worth more than $1000 in the future because the $1000 today can be invested to be more than $1000 in the future. The amount that future cash flow is discounted is the “risk free rate”. We have assumed a risk free rate equal to the cash rate.

User Defined Parameters

Parameters that can be changed by users to change the selected formula's result include the following:

Earnings Growth Rate

This percentage amount represents the amount of average annual growth anticipated in the period selected in the Years to Forecast setting.

The value is an average of analysts forecasts for EPS growth over 5 years which is then averaged.

Terminal Earnings Growth

This percentage amount represents the growth in earnings after the number of years forecast to infinity.

The default value is 0%, which means that after the number of years forecast, it is assumed that earnings will stay the same from year to year.

Risk Free Rate

This percentage amount represents the risk free rate which is usually taken to be the cash rate or the yield from AAA bonds.

The default value is the current yield from AAA bonds.

Results

Fair Value

The Fair Value calculation results are displayed after the calculator name in the Calculator Selection List.

Users cannot directly alter the resulting Fair Value, however changing the highlighted parameters (yellow background and blue outline) will normally result in a change in results for that calculator and any other calculators that use those parameters.

Results in Table and Graphs

Some of the results for the individual stock can be displayed in tables and graphs in the Results Display area on the right side of the work page.

For a detailed description of these tables and graphs, go to the Results Display topic.

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