A practical guide to discounted cash flow valuation

FundSpec, 8 September 2026

A discounted cash flow valuation answers one question: what is a stream of future cash worth today? Applied to a company, it says that a share is worth the cash the business will generate for its owners over its life, discounted for the fact that cash later is worth less than cash now. It is the most rigorous valuation method available and the easiest to abuse, because a handful of assumptions decide the answer. This guide explains the pieces and how to keep them honest.

Which cash flow

The first choice is what to project. Dividends are the cash a shareholder actually receives, and a dividend discount model suits mature companies that pay out most of what they earn. Earnings per share are a broader proxy for the cash available to shareholders. Free cash flow to equity is the cash left after operations, investment and debt service, and it is the most direct measure of what the business could pay out. Free cash flow to the firm values the whole enterprise before debt, and is built from revenue through margins, taxes, investment and working capital; it suits companies whose capital structure is changing.

The choice should follow the company. A bank is valued on equity cash flows; an industrial with heavy debt is easier to value at the firm level and then adjusted for net debt.

Growth and stages

Cash flows are projected forward for a number of years. A single stage model applies one growth rate forever and is only sensible for a stable, mature business. A multi stage model projects a period of higher growth that fades to a steady rate the economy can sustain, which is closer to how most companies behave. FundSpec seeds the growth assumptions from the company's own history, its three and five year growth in earnings and free cash flow, so that the starting point is a fact rather than a hope, and lets you override it.

Growth is where optimism hides. A company growing at thirty percent will not do so for ten years, because it would become larger than its market. The discipline is to ask what the business would have to look like at the end of the projection for the growth rate to have held, and to check that against the size of the industry.

The discount rate

Future cash is discounted at a rate that reflects its risk. For equity cash flows the rate is the return a shareholder requires for holding this stock rather than a safe asset; for firm cash flows it is the weighted average cost of capital, blending the cost of equity with the after tax cost of debt in proportion to how the company is financed. A percentage point on the discount rate moves a valuation more than most people expect, which is why FundSpec's DCF includes a sensitivity table showing the fair value across a grid of discount rates and growth rates. If the stock is only cheap at the most favourable corner of the grid, it is not cheap.

Terminal value

Most of a DCF's value sits beyond the projection period, in the terminal value that stands for every year after the last one modelled. It is computed either by growing the final year's cash flow at a perpetual rate and capitalising it, or by applying an exit multiple, a price to earnings or price to free cash flow ratio the company might trade at in the final year. The perpetual growth rate must be below the discount rate and should be near the long run growth of the economy; anything higher is a claim that the company outgrows the world forever. An exit multiple should be checked against what comparable companies trade at today.

Because the terminal value is so large a share of the total, the two methods should give similar answers. When they do not, one of the assumptions is wrong.

Testing a valuation

A DCF produces a number with false precision. The way to use it is to test it. Run the sensitivity table. Build a downside case with lower growth and a higher discount rate, and see whether the stock is still worth holding at that value. Then run the model backwards: a reverse DCF takes the current price and solves for the growth the market is implying. If the market price implies growth you find implausible, you have a view; if it implies growth the company has delivered for years, the stock is fairly priced and the model has told you something useful by disagreeing with you.

How FundSpec shows it

Subscribers build a DCF from the My Models screen, either through a step by step wizard that explains each assumption as it asks for it or through a worksheet where every input is live. The model is seeded from the company's filed financials, supports dividends, earnings, free cash flow to equity and firm cash flows, single and multi stage growth, a cost of capital builder, perpetual growth and exit multiple terminal values, the sensitivity grid and the reverse DCF, and saves the model to your account. Every stock page also shows FundSpec's own fair value estimate, produced by a different method that prices the company against its peers, so that your DCF has something to argue with.