Key insights
- The article outlines a simplified approach to calculating the intrinsic value of a stock using discounted cash flow (DCF) analysis. It emphasizes using free cash flow, conservative growth estimates, and a reasonable discount rate to determine if a stock is undervalued, overvalued, or fairly priced. While not a market-moving event, it provides a framework for individual investors to assess stock valuations, potentially influencing buying/selling decisions.
Most of this community is appropriately index first and I think that approach is right for the core of a portfolio but a lot of people here also hold a handful of individual positions alongside their funds and for those names it's worth having some framework for whether you're paying a reasonable price. The version of intrinsic value I've found most approachable is this.
Intrinsic value is what a business is worth based on its expected future cash flows, discounted back to today at the rate of return you require. That's it. Everything else is implementation.
Start with free cash flow rather than earnings. It's on the cash flow statement as operating cash flow minus capital expenditures and it represents the actual cash the business generates and can theoretically return to owners. It's also considerably harder to shape through accounting choices that don't affect real cash generation which makes it a more trustworthy starting point than net income.
Estimate a growth rate for the next ten years and be deliberately conservative about it. If a company has grown FCF at 12% historically, using 8% is more defensible than assuming the trend continues. Most valuations go wrong in the optimism of the growth assumptions rather than in the mechanics.
Discount those projected cash flows at your required rate of return, typically 10% as a starting point since that approximates long-term equity market returns.
Add a terminal value for everything beyond year ten using a long-term growth rate around 2-3%, roughly in line with nominal GDP growth. Sum it all up and divide by shares outstanding and you have your per share estimate.
What matters most is not the precision of the number but the comparison it enables: is this clearly cheap relative to that estimate, clearly expensive or genuinely ambiguous? I use valuesense for the actual modeling work now because manually building DCFs in a spreadsheet introduces quiet compounding errors that are tedious to track down.