Should you use Discounted Cash Flow (DCF) before buying the stock?

What is discounted cash flow and why is it important?

The discounted cash flow (DCF) method is a valuation method that is used to determine the present value of an investment based on its future cash flows. It is a widely used method for valuing assets such as stocks, bonds, and real estate. In this blog, we will take a detailed look at the DCF method and provide an example of how it works.

To begin, let’s define some key terms:

• Cash flow: The amount of money coming into or going out of an investment.
• Present value: The current worth of a future sum of money, taking into account the time value of money.
• Time value of money: The idea that money is worth more in the present than in the future, due to the potential for it to earn interest.

Now, let’s look at the basic formula for the DCF method:

Present value = (Future cash flow / (1 + discount rate))^n

Where:

• Future cash flow: The amount of cash flow expected in the future.
• Discount rate: The required rate of return that an investor expects to receive on an investment.
• n: The number of periods in the future that the cash flow is expected to occur.

Now, let’s look at an example of how the DCF method works.