Lesson 1 of 8
What a DCF is really doing
The arithmetic of a discounted cash flow is settled. Every input is a claim about the future, and the model returns a number for claims nobody could defend.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- The discounting is an identity. Nothing in a DCF is contested except the numbers you put into it.
- The model never refuses. It returns a confident figure for a growth rate and a margin the company has never earned.
- A DCF is a way of writing your assumptions down in a form that can be argued with, not a machine for producing a value.
A discounted cash flow says one thing: a business is worth the cash it will hand over, with later cash counted for less. That sentence is not controversial. The controversy is entirely in the two words "will hand over".
Where the model's value comes from: Procter and Gamble, forecast years against everything after
Nearer
- Years 1 to 10, discounted$117.8bn40%
- Everything after year 10, discounted$175.7bn60%
Furthest out
Total$293.5bn
The identity, then five decisions
The engine is four lines of arithmetic. Grow the cash flow, discount each year, value everything after the forecast as a perpetuity, add it up. Nobody argues with any of it.
Five decisions arrive before the arithmetic does, and every one of them is a claim about a business rather than a fact about a spreadsheet.
| Decision | What you are claiming |
|---|---|
| Which cash flow | Which definition of "cash the owners get" you mean |
| The growth rate | How fast that cash grows, and for how long |
| The forecast length | How far ahead you can see at all |
| The discount rate | What this cash is worth against the alternatives |
| The terminal assumption | What the business is when the forecast runs out |
The model does not refuse
This is the property that matters and the one a spreadsheet hides. A filing refuses: the earnings per share line is either there or it is not. A model never does. Type a 40 percent growth rate into a company that has grown at 2 percent for a decade and the answer comes back to two decimal places.
One point on the rate moved the answer by about 18 percent. No filing was consulted to produce that move, and no reader of the output would know it had happened.
So what is it for
Not for producing a value. For making a claim explicit enough to attack.
A number without its inputs is unreadable to the person who did not build it, including the person who did build it six months later. A number with its five decisions written beside it is a position: this company grows at 3 percent, the capital costs 8 percent, and the business is still here in year eleven. Each of those can be argued with, and being argued with is the whole value of the exercise.
The rest of this course takes those five decisions one at a time on the same company, measures what each is worth in dollars, and ends by asking which companies should not be put through the model at all.
Check yourself
Which part of a discounted cash flow is actually in dispute?
- The discounting arithmetic
- The inputs: which cash flow, how fast it grows, for how long, and at what rate it is discounted
- Whether later cash is worth less than cash today
Show the answer
Answer: B.
The arithmetic is an identity that nobody argues with. Every disputed thing in a valuation arrives before the arithmetic starts.What happened to the Procter and Gamble value when only the discount rate moved from 8 percent to 9 percent?
- Nothing, because the cash flows were unchanged
- It fell about 18 percent, from 110.81 to 92.02 per share
- It rose, because a higher rate means a higher return
Show the answer
Answer: B.
One point of discount rate moved the answer by roughly a fifth on a company whose filed figures did not change at all.What is the practical purpose of building a DCF?
- To produce the intrinsic value of a company
- To state a set of assumptions precisely enough that someone can argue with them
- To replace judgement with arithmetic
Show the answer
Answer: B.
The output is only as good as five judgements. Writing them down where they can be contested is what the model is for.Sources
- Williams, The Theory of Investment Value, 1938: value as the present value of the cash a security distributes.
- Berkshire Hathaway shareholder letter, 2000: every valuation reduces to how certain the cash is, when it arrives, how much it is, and the risk-free rate.
- Procter and Gamble, Form 10-K, fiscal year ended 30 June 2026, filed 2026-08-04, accession 0000080424-26-000103: operating cash flow, capital expenditure, debt, cash and diluted share count.
What this leaves out
- The figures above are one company on one set of assumptions. They are arithmetic on filed inputs, not a view about the company.
- The share price and every market figure in this course is a stored close, not a live quote.
- ValueScreener's estimated cost of capital is an estimate built from a dated Treasury yield, a measured beta and an assumed premium. It is not an observation.
- Nothing here is advice about any security.