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title: "What Is DCF Valuation? — Step-by-Step Guide | Stock Expert AI"
description: "DCF (Discounted Cash Flow) valuation explained: how it works, when to use it, step-by-step calculation, and its limitations."
---

# What Is DCF Valuation? — Step-by-Step Guide | Stock Expert AI

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## What is DCF Valuation?

Discounted Cash Flow is the gold standard of equity valuation. Here's how it works in plain English — and when it breaks.

## Quick Answer

DCF (Discounted Cash Flow) valuation estimates a company's intrinsic value by projecting its future cash flows and 'discounting' them back to present value using a required rate of return. The idea: a dollar earned 5 years from now is worth less than a dollar today, because you could invest that dollar now. DCF works best for stable businesses with predictable cash flows (utilities, mature tech). It breaks down for early-stage companies, cyclicals, and distressed firms.

## Step 1: Project Free Cash Flow

Estimate the company's Free Cash Flow (FCF) for the next 5-10 years. FCF = Operating Cash Flow - CapEx. Base projections on historical growth rates, margin trends, and industry outlook. This is the most subjective and most important step.

## Step 2: Choose a Discount Rate

The discount rate is your required rate of return, typically the Weighted Average Cost of Capital (WACC). For US stocks, WACC ranges from 7-12% depending on risk. Higher-risk companies get higher discount rates.

## Step 3: Calculate Terminal Value

Beyond year 10, assume a perpetual growth rate (usually 2-3% — in line with long-term GDP growth). Terminal Value = FCF_year10 × (1 + g) / (WACC - g). This often accounts for 60-80% of the final valuation.

## Step 4: Discount & Sum

Discount each year's FCF and the terminal value back to present value: PV = FV / (1 + WACC)^n. Sum all the present values to get the enterprise value. Subtract net debt to get equity value. Divide by shares outstanding to get intrinsic value per share.

## Limitations

Small changes in growth rate or discount rate cause huge swings in DCF output. Garbage in, garbage out. Never use DCF as the sole valuation method — combine with multiples-based valuation (P/E, EV/EBITDA) for a sanity check.

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