AGUILA, PAULO TIMOTHY DR.

III – BSA

Discounted Cash Flow Method: How to Value a Company the Warren Buffett Way (DCF Valuation
Explained)

What is a discounted cash flow analysis?

While relative value is based on the value of similar assets, absolute valuation approached examine the
intrinsic value of an asset without comparing it to any other comparable assets.

STEP 1
BACK TO THE BASICS
Intrinsic value

Sound investing
Paying less for an asset than it is worth

Price and value are different

Assets that don't throw off cash flows have no intrinsic value.

A DCF can only be used for cash-generative assets.

STEP 2
DCF INGREDIENTS

Company Valuation
A DCF is the theoretically most accurate way to estimate a firm's intrinsic worth.

DCF Ingredients
Free Cash Flow
Growth
Terminal Growth Rate
Liabilities
Excess Cash
Discount Rate

STEP 3
LIMITATIONS

"To a man with a hammer everything looks like a nail"

"You could ask 100 world-class investors to determine the intrinsic value of one and the same company
and they would probably all come up with different estimates"

Assumptions always carry a large degree of error

Be Approximately Right
The point is assessing if a stock is attractively valued or not based on reasonable assumptions for cash
flow generation in the future.

STEP 4
THE DISCOUNT RATE

WACC - Weighted Average Cost of Capital

Discount rate = Your required rate of return.

If you require a bigger rate of return, the company will be worth less today than if you require a smaller
return.

Speaking of discount rates, your goal should be to invest your capital at a rate of return that surpasses
what you can easily achieve elsewhere.

STEP 5
MARGIN OF SAFETY

"In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase,
'this too will pass.' Confronted with a like challenge to distill the secret of sound investment into three
words, we venture the motto MARGIN OF SAFETY. This is the thread that runs through all the preceding
discussion of investment policy - often explicitly, sometimes in a less direct fashion." - Benjamin Graham

If you have misjudged the intrinsic value of a business, buying with margin of safety gives you some
cushion.

MARGIN OF SAFETY
If you buy stocks with a MOS, you may end up with higher returns than your discount rate.

To successfully apply the tool of a DCF requires extraordinary qualitative judgment and analysis