After work, I sat down at a café near my home and opened my laptop.
Today, I decided to calculate the true value of one of my watchlist stocks.
Price fluctuations are normal in the stock market,
but knowing whether a stock is overpriced or undervalued is one of the most critical parts of investing.
When I make that judgment, I often rely on the Discounted Cash Flow (DCF) method.
This approach is like pulling the future of a company into the present to see its worth in today’s money.
1. What Is the Discounted Cash Flow (DCF) Method?
DCF is a valuation technique that forecasts a company’s Free Cash Flow (FCF)
and discounts those future cash flows back to their present value to estimate the company’s fair value.
In simple terms:
“If we convert the money the company will make in the future into today’s value, how much is it worth?”
2. The Basic Formula
The core DCF formula is:
Company Value = ∑ (Future Cash Flow ÷ (1 + Discount Rate)^n)
- Future Cash Flow: The free cash flow remaining after operating expenses and capital expenditures
- Discount Rate: The return rate required by investors (cost of capital)
- n: The year in which the cash flow is received
3. Why Is DCF Important?
- Provides a stable benchmark unaffected by short-term market swings
- Adds objectivity to investment decisions
- Quantifies growth potential in clear numbers
After I learned DCF, I stopped relying on vague feelings like “this stock seems cheap” or “that stock looks expensive.”
Instead, I gained confidence backed by numbers.
4. Example – A Simple DCF Calculation
Let’s imagine a company that generates ₩100 million in free cash flow per year,
and that cash flow is expected to grow by 5% annually.
We’ll set the discount rate at 8%.
- Year 1 PV: ₩100,000,000 ÷ (1 + 0.08)^1 ≈ ₩92,590,000
- Year 2 PV: ₩105,000,000 ÷ (1 + 0.08)^2 ≈ ₩90,160,000
… and so on, for 5–10 years, summing each year’s present value.
Finally, we add the Terminal Value — the present value of all cash flows beyond the projection period — to arrive at the company’s fair value.
5. Key Points to Keep in Mind When Using DCF
- Realistic cash flow forecasts
- Overly optimistic projections will distort the valuation
- Proper discount rate selection
- Riskier companies require a higher rate, stable companies a lower one
- Multiple scenarios
- Compare optimistic, base, and pessimistic cases to gauge risk
6. Final Thoughts – Value First, Price Second
Instead of looking at the price chart first, calculate the company’s value first.
DCF is more than just number crunching — it’s a form of time travel that lets investors bring the company’s future into today’s terms.
The market sets the price, but the investor calculates the value.
When the gap between value and price is large, that’s when real opportunities appear.
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