The Discounted Cash Flow (DCF) method helps estimate a company's value based on the cash it may generate in the future.

At Valestor, DCF is available alongside the Peter Lynch valuation method. The former focuses on future cash flows, while the latter looks at a company's earnings, historical growth, and market valuation. Both methods provide different perspectives on a stock, but their results depend on the underlying data and assumptions.

How Valestor Calculates a Company's Value Using DCF

1. Determine Free Cash Flow

The model uses the company's Free Cash Flow (FCF) from the latest completed fiscal year as its starting point. FCF represents the cash remaining after operating activities and capital expenditures.

FCF helps assess a company's ability to fund growth, reduce debt, and return capital to shareholders.

2. Project Future Cash Flows

In the current Valestor model, cash flows are projected three years ahead using the historical five-year compound annual growth rate (CAGR) of FCF.

The projection formula is:

FCF_t = FCF₀ × (1 + g)^t

Where FCF₀ is the initial free cash flow, g is the historical growth rate, and t represents the forecast year.

Historical CAGR is calculated using the following formula:

CAGR = (FCF_n / FCF₀)^1/n − 1

Where n is the number of years between the initial and final values.

The model assumes that the historical growth rate will continue throughout the forecast period. However, past performance does not guarantee similar growth in the future.

3. Discount Future Cash Flows

Future cash flows are converted into their present value using the Weighted Average Cost of Capital (WACC). It reflects the cost of financing a company through both equity and debt.

The cost of equity is estimated using the Capital Asset Pricing Model (CAPM):

R_e = R_f + β × (R_m − R_f)

Where R_f is the risk-free rate, β is the stock's beta coefficient, and R_m is the expected market return.

Valestor uses the following predefined assumptions:

The discount rate has a significant impact on the valuation: the higher the WACC, the lower the present value of future cash flows, all else being equal.

4. Calculate Terminal Value

To account for cash flows beyond the three-year forecast period, the model uses the Gordon Growth Model:

TV = FCF₃ × (1 + g_t) / (WACC − g_t)

Where FCF₃ is the free cash flow in the third forecast year, g_t is the long-term growth rate, and WACC is the discount rate.

The model uses the latest annual GDP growth rate of the issuer's country as the long-term growth assumption: 2.3% for US stocks and 1.0% for MOEX stocks.

The formula is applied only when WACC exceeds the long-term growth rate. Terminal value is also discounted to its present value and may account for a substantial portion of the total valuation.

5. Calculate the Value per Share

The model adds the present value of projected cash flows and the discounted terminal value to determine the company's Enterprise Value (EV).

Net debt is then subtracted:

Value per Share = (EV − Net Debt) / Number of Shares

The result represents an estimated share value based on the model's assumptions, not a prediction of its future market price.

DCF and Peter Lynch: Two Approaches to Stock Valuation

The Peter Lynch method helps compare a company's earnings, historical growth, and market valuation.

DCF evaluates a business through its future cash flows and illustrates how the discount rate and long-term assumptions affect its estimated value.

If the two valuations differ significantly, it is worth investigating the reasons. For example, earnings may be growing at a different rate than cash flow, or the company may have substantial capital expenditure requirements or debt.

Conclusion

DCF and the Peter Lynch method offer different perspectives on a company's value. Comparing their results can provide additional insight, but neither method replaces a thorough analysis of financial statements and business quality.

This material is for informational purposes only.

It does not constitute individual investment advice.