Discounted cash flow (DCF) refers to a valuation method that estimates the value of an investment using its expected future cash flows.
DCF analysis attempts to determine the value of an investment today, based on projections of how much money that investment will generate in the future.
It can help those considering whether to acquire a company or buy securities make their decisions. Discounted cash flow analysis can also assist business owners and managers in making
capital budgeting or operating expenditures decisions.
Finding the value of a company matters a great deal; some would argue that it remains the single most important item on anyone’s checklist. Figuring out how much the company is worth or its intrinsic value
will help you determine your price and what kind of long-term return you might achieve.Using a discounted cash flow model, or DCF, is one of the more common styles of
determining that value, but we have another option: the reverse DCF.
KEY TAKEAWAYS
- Discounted cash flow analysis helps to determine the value of an investment based on its future cash flows.
- The present value of expected future cash flows is arrived at by using a projected discount rate.
- If the DCF is higher than the current cost of the investment, the opportunity could result in positive returns and may be worthwhile.
- Companies typically use the weighted average cost of capital (WACC) for the discount rate because it accounts for the rate of return expected by shareholders.
- A disadvantage of DCF is its reliance on estimations of future cash flows, which could prove inaccurate.
KEY TAKEAWAYS
- One of the problems with using a DCF is that it requires us to use a healthy dose of guesswork to determine the growth of future cash flows, along with the discount rates
required to guess at the company’s risk level.
- We have a solution to this guesswork problem: working backwards by utilizing a reverse DCF. Instead of projecting future cash flows, the reverse DCF takes the current
share price and works backward to project how much cash flow would be required to generate its current valuation. Once we have determined the possible cash flows,
we can determine if the price is reasonable.
- Reverse engineering the DCF allows the investor to remove some uncertainty. The reverse DCF starts with the price, which we know from any stock ticker, and removes the
doubt of projecting future cash flows.
- If the reverse-engineered DCF assumes more cash flows than the company can reasonably produce, then the company remains overvalued. If the opposite is true, then the
company is undervalued.
Good Understanding to topics such as P&L Statement,BalanceSheet,Cash Flows are required.
Reading Annual Reports of Listed Companies and understanding Financial Statements are super important.
Sharing Resources in Term's of Videos, Excel Sheets,Pdf's and python Code for understanding of DCF and Reverse DCF Model.