Know more about Discounted Cash Flow (DCF), an effective method of calculating DCF, and the ideal number to use for Terminal Value.

1. Discounted Cash Flow &
Stock Valuation
By Jae Jun
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2. What You Will Learn
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3. ● The purpose of using
DCF
● The advantage of the F
Wallstreet method
● The ideal number for
Terminal value
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4. The purpose of the
Discounted Cash Flow
valuation is to find the
sum of the future cash
flow of the business and
discount it back to a
present value. Photo credit: 401(K) 2013 / Foter / CC BY-SA

5. I use the F Wall Street
method of valuing a
business along with
some tweaks in the free
and best valuation
spreadsheets you can
find on this site.Photo credit: Andos_pics / Foter / CC BY-NC-SA

6. The advantage of this
method is that it requires
the investor to think
about the stock as a
business and analyze its
cash flow rather than
earnings. Photo credit: opensourceway / Foter / CC BY-SA

7. The first and foremost
reason a business exists
is to make money where
money = cash, not
earnings.
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8. Since cash is what a
business needs in order
to maintain and grow its
operations,
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9. it’s only right to consider
the possibility of its
future cash growth rather
than earnings growth.
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10. The disadvantage is that
DCF is not suitable for
start ups,
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11. growth companies or
capital intensive
companies where the
cash flow cannot be
accurately determined.
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12. The error of prediction
and assumptions must
also be dealt with in the
DCF, which we cover with
margin of safety.
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13. I’ll go through the many
assumptions to consider
with a DCF and how to
effectively use it with the
stock valuation
calculator.
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14. Discounted Cash Flow
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15. FCF = Cash from
Operations – Capital
Expenditure

16. The number we want to
use is the cash generated
from ongoing business
operations.
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17. This is the cash that is
recurring and will allow
the business to grow.
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18. Cash from one time sales
of property or a
subsidiary should be
taken out, it is of low
importance compared to
the recurring cash.
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19. Since we are looking at
cash over different
timeframes to normalize
the data,
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20. I don’t believe it to be a
cause of concern.
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21. Excluding these items
would provide a better
indication of how the
cash has been growing
before these additional
additions.
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22. This would not produce a
more conservative
number but a better
indication of the actual
FCF growth.
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23. If we use FactSet
Research Systems (FDS)
as an example,
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24. the median FCF growth
over 10 years is 29.8%
whereas the FCF value
minus taxes and other
produces a median FCF
growth of 34.1%.
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25. To truly get a better
accuracy in your DCF, the
amount of maintenance
capex and capex used for
growth has to be
distinguished.
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26. Expected Growth
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27. This is where we get to
the artsy side of the DCF
and where we have to
come up with a number
for the indefinite future.
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28. I generally use the
median FCF growth over
10 or 5 years depending
on the company.
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29. I also compare it to the
PE since that is what the
market expects from the
company.
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30. The exception is when
the FCF growth rate or PE
are ridiculously high, it’s
unsustainable.
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31. My cap for the highest
growth is limited to 15%
to be conservative.
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32. The goal of choosing a
growth rate = find a
number which is
conservative yet not low
balling,
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33. and close to reality in
order to capture potential
future gains without
eliminating too many
investment candidates.
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34. Discount Rate
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35. I lean very strongly
towards present dollars
rather than future dollars.
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36. I use a high discount rate
because I prefer the
certainty of the present
cash rather than the
uncertainty of the future.

37. People in the finance
world pour out their
hearts to obtain the most
accurate discount rate by
analysing -
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38. ● risk free rates,
● beta,
● risk premium and
● WACC.
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39. I say rubbish to all this.
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40. What’s the point in
learning every method of
hammering a nail when
all you have to do is hit it
on the head.
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41. Graham - Buffett
investments are based on
common sense, not
volatility and other
mumbo jumbo.
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42. Terminal Value
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43. Since it isn’t practical to
forecast cash flows for an
infinite number of years,
it’s usual to end the DCF
with a terminal value.
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44. On the spreadsheet, the
terminal value is 3%
(although the text says
5%).
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45. Discounted Cash Flow
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46. DCF receives a bad rep
with the crowd and
growth players because
they call it driving with
the rear-view mirror.
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47. But in the private
business world where
estimates and PE’s are
absolutely irrelevant,
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48. cash is what is used to
judge the value of a
business.
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49. For an idea of the
accuracy of a Discounted
Cash Flow analysis,
check out my intrinsic
values vs Morningstar’s.
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50. Old School Value
Jae Jun (jae.jun@oldschoolvalue.com)
http://www.oldschoolvalue.com
Old School Value improves your
investment decisions and performs deep
fundamental analysis and valuation for
you. Just like a personal stock analyst.