Discounted Cash Flow valuation is an important part of value investing, and something that new investors are often using before they even hear its defined name. However, actually calculating the DCF value can be tricky, especially if you do not have automated tools to handle it.
But what is Discounted Cash Flow (DCF) value, why does it matter, and how can you calculate it quickly without having to use expensive third-party services or incredibly difficult formulas?
The Basics of Discounted Cash Flow Value
DCF value represents the “true value” of an investment. This value is based on estimations and projections of the investment’s future earnings, essentially using existing data to judge whether or not that investment will turn a profit or not.
While this might sound like common sense in the world of investing, DCF value is actually a core part of how many people handle their investments and can be a surprisingly complex metric to work with. In general, DCF value is meant to be a point of comparison, giving investors a new metric to work with when they are considering multiple different investment opportunities.
In simple terms, DCF value comes from calculating forecast cash flow and discount rates, arriving at a terminal value, and then discounting that terminal value to get the estimate you need.
As a simplified example, if two companies are both valued at $50 million at the exact same moment, but one has a higher DCF value than the other, investors might choose to invest in that company instead of the lower-valued one. This is because the higher-valued company is projected to earn more in the future, increasing its value to the investor as a result.
How Does DCF Value Work?
DCF value estimates the money that an investor would receive for their investment over a given period of time, essentially telling them the expected returns for whatever investment they are looking at. While these estimations are only guesses, they are still based on hard data and can help investors make informed decisions about which companies or investments they want to pursue.
Discounted Cash Flow value is more or less a shorthand way to tell which investment opportunities are most likely to see the highest success and is a popular metric for investors who are primarily looking for consistently higher returns as the main metric behind their investment decisions.
Calculating DCF Value
If you are interested in using DCF value as part of your own investing process, it is a good idea to avoid trying to calculate it manually. While anybody can technically calculate DCF value themselves, there are tools that can expedite the process significantly and remove the risk of human error.
Instead, online tools like the Alpha Spread dcf calculator are usually a good place to turn. These free online calculation tools provide a fast, accurate way to calculate the DCF value of any investment you are interested in, serving as unbiased, impartial estimates of an investment’s true value.
Overall, the value of DCF value lies in its ability to provide an estimation that is based on solid data rather than guesses or assumptions. By using it correctly, you can make more informed investment decisions to a good degree of accuracy and can avoid spending too much time on analyzing investments that simply are not very likely to lead to big returns.