1. Project free cash flows
Estimate free cash flow for the next 5-10 years using a growth rate grounded in the company's history, not hope.
How to calculate
How to calculate intrinsic value (DCF)
The most common way to calculate intrinsic value is a discounted cash flow (DCF): project a company's future free cash flows, discount each back to today using a discount rate (usually WACC), add a terminal value for the years beyond the forecast, sum everything, subtract net debt, and divide by shares outstanding for a per-share intrinsic value.
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Short answer
A DCF estimates intrinsic value as the present value of all future free cash flows. Project the cash flows, discount them at the WACC, add a terminal value, sum, and divide by shares. Then demand a margin of safety, because DCFs are precise but not accurate.
Step by step
2. Pick a discount rate
Use the company's WACC (often 8-10%): the rate that reflects risk and the time value of money.
3. Discount each year to today
Divide each year's projected FCF by (1 + rate) raised to the power of the year number to get its present value.
4. Add a terminal value
Capture value beyond the forecast (Gordon growth: final-year FCF x (1 + g) / (rate − g)), then discount it back to today.
5. Sum, adjust, and per-share
Add all present values, subtract net debt, divide by shares outstanding. Compare the result to the market price.
A simplified worked example
Suppose FCF is $100M growing 8% for 5 years, discounted at a 10% WACC. The five discounted cash flows sum to roughly $410M. A terminal value (say final-year FCF growing 3% forever, capitalised at 10% − 3% = 7%, then discounted back) might add ~$1.3B. Total enterprise value ~$1.7B; subtract $200M net debt → $1.5B equity value; over 100M shares that's an intrinsic value near $15/share.
Change the growth rate to 6% or the discount rate to 11% and the answer moves materially, which is the whole point of Graham's margin of safety: only buy meaningfully below your estimate, because the estimate itself is uncertain.
Intrinsic value (DCF) calculator
A simplified 2-stage DCF. Cash figures in millions; rates as percents.
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Related
- What is intrinsic value? - the concept behind the calculation.
- What is DCF valuation? - the 3-stage model in more depth.
- What is WACC? - the discount rate the model depends on.
- How to calculate margin of safety - the discount to demand once you have an intrinsic value.
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