Valuation: DCF

What it is

You project free cash flows over an explicit forecast period (typically 5–10 years), discount them to present value at a cost of capital, and add a terminal value. The output: a per-share intrinsic value independent of current trading multiples.

The most rigorous valuation framework in the toolkit, and the most contestable. Activists use it sparingly because every assumption becomes a battleground; bulls use it more for special-situation theses where stable cash flows are the entire argument.

When to use

• ✅ Stable, predictable cash flow profile (utilities, infrastructure, long-duration contracted revenue)
• ✅ Special situations where terminal value carries the thesis (recovery plays, regulatory transitions)
• ✅ The user can defend the WACC and growth assumptions to a sceptical audience
• ❌ Cyclical or commodity-exposed businesses (multiple-comp better)
• ❌ Hyper-growth tech (terminal-value sensitivity makes it brittle)
• ❌ When peer multiples are abundant and clear (use multiple-comp instead)

Methodology

1. Project unlevered free cash flow for 5–10 years
   • Revenue → EBITDA → EBIT → NOPAT → +D&A → -capex → -ΔWC = FCF
2. Calculate WACC:
   • Cost of equity (CAPM: Rf + β × ERP)
   • After-tax cost of debt
   • Capital structure weights (target, not current)
3. Discount each year's FCF to PV
4. Calculate terminal value at the end of explicit period:
   • Gordon Growth: TV = FCF × (1+g) / (WACC - g)
   • Or exit-multiple approach: TV = year-N EBITDA × exit multiple
5. Sum PV of FCF + PV of TV = Enterprise Value
6. Subtract net debt → Equity Value
7. Divide by share count → Per-share intrinsic value

Sensitivity matrix

The non-negotiable add-on. Show how intrinsic value varies across:

• WACC ± 100bps
• Terminal growth rate ± 100bps
• Exit multiple ± 1×

                Terminal Growth
WACC          1.5%    2.0%    2.5%    3.0%
8.5%          $52     $58     $66     $76
9.0%          $46     $51     $57     $65
9.5%          $41     $45     $50     $56
10.0%         $37     $40     $44     $49

Without the matrix, readers anchor on a single number and dismiss it. With the matrix, the range becomes the conversation.

Common defences against DCF rebuttals

Exemplars

• Pershing Square · Fannie Mae / Freddie Mac (Jan 2025) — DCF thesis on emerging-from-conservatorship cash flows
• Pershing Square · ADP (Aug 2017) — partial DCF as part of multi-method valuation
• Trian · GE (Oct 2015) — segment-level DCF combined with SoP
• Greenlight · Peloton (Oct 2024) — DCF on subscription business (2.5 turns of margin expansion + steady-state FCF) implies $7.50–$31.50

Full list: examples/by_valuation.json → dcf

See also

• valuation/multiple-comparison.md — most common alternative
• valuation/lbo-math.md — close cousin (PE buyer perspective)
• theses/undervaluation.md — DCF often anchors undervaluation
• slides/sum-of-parts-reveal-recipe.md — the "big number" slide