Getting started
Learn how to put a price on a stock yourself: turn a company's future cash into a value per share, then decide if it's undervalued, overvalued, or fairly priced.
About 8 minutes to read, 8–10 minutes for the 12-question quiz. Have a calculator handy for 4 of the questions. For educational purposes only — not investment advice.
Step 1 of 5
What it is
A dollar in your hand today is worth more than a dollar promised to you later. Money you have now can be invested and earn a return, and inflation slowly shrinks what a future dollar can buy. That gap between "now" and "later" is the time value of money.
The two formulas
Everything in a DCF is built from two moves. Compounding pushes money forward in time (present value → future value). Discounting pulls money back (future value → present value). Here r is the annual rate and n is the number of years.
Try it both ways
Push forward: $1,000 invested at 5% for 10 years grows to $1,628.89. Pull back: a promise of $1,000 in 3 years, when you could earn 10% elsewhere, is worth only $751.31 today.
Why it matters for stocks
A stock is a claim on all the cash the business will produce in the future. Because those dollars arrive over many years, you can't just add them up — you discount each one back to today, then total them. That total is what the business is worth now, and it's the heart of a DCF (discounted cash flow) model.
Step 2 of 5
What it is
Free cash flow (FCF) is the cash a business generates after paying for the investments it needs to keep running and growing. It's the money that could actually be handed to owners.
Why FCF and not earnings
Net income includes accounting choices and non-cash items, so a company can report a profit while burning cash. FCF is harder to dress up, which is why most DCFs start there.
How to find it
Both numbers are on the cash flow statement in the company's annual report (10-K), and most finance sites list FCF directly. Start with the last twelve months, or the average of the last three years if it's lumpy.
Building the forecast
Pick a growth rate and project five years out. Anchor it to reality: the company's own history, analyst estimates, and what's plausible for its size. Fast growers should fade toward slower growth as they mature. Below is our practice company, "Example Co.": $100M of FCF today, growing 8% a year.
Step 3 of 5
What it is
The discount rate is the annual return you demand for tying your money up in this stock. Professionals use a company-specific figure called WACC. As an individual investor, a common shortcut is 8–10% — near the long-run return of the stock market — going higher for riskier companies.
Why it matters so much
A higher discount rate shrinks the value of every future dollar, and the effect grows the further out the cash is. The same $1,000 arriving in 10 years is worth very different amounts depending on the rate you choose:
Discounting Example Co.'s forecast
We use 10%. Each year's cash flow is divided by 1.10 raised to that year's number.
The trap to avoid
Picking a discount rate that "makes the answer work." Choose it first, based on the risk you're taking, then let the model tell you what it says.
Step 4 of 5
What it is
Your forecast stops at year 5, but the company doesn't. Terminal value is the value, at the end of the forecast, of every cash flow after that. The standard shortcut assumes the cash flow grows at a slow, steady rate forever (the perpetuity growth formula).
Choosing the growth rate (g)
Keep it modest: roughly 2–3%, in line with long-run economic growth and inflation. It must always be lower than your discount rate, otherwise the formula breaks. No company outgrows the whole economy forever.
Example Co.
Year-5 FCF is $146.9M, g is 3%, and r is 10%. That gives a terminal value at year 5 — which we then discount back to today like any other future cash.
The sobering part
Notice that $1,342M of Example Co.'s value comes from the terminal value, versus just $473M from the five years you actually forecast. In most DCFs, 60–80% of the value sits in the terminal value — so small changes to g and r move the answer a lot.
Step 5 of 5
Step A: enterprise value
Add the discounted forecast and the discounted terminal value. That's the value of the whole business.
Step B: per-share value
Enterprise value belongs to lenders and owners. Subtract net debt (debt minus cash) to get the owners' share, then divide by shares outstanding. Example Co. has $200M net debt and 50M shares.
Step C: compare to the price
Your DCF value is an estimate, so give it a fair-value band of about ±10%. Around $32.32, that's roughly $29–$36. Then look at where the stock actually trades:
| Price $27 (16% below value) | Undervalued |
| Price $32 (inside the band) | Fairly priced |
| Price $40 (24% above value) | Overvalued |
Stress-test it
Change one input and watch the value move. Raise the discount rate from 10% to 11% and Example Co. drops to about $27.67. Lower it to 9% and it rises to about $38.52. Because of that, run a few scenarios and demand a margin of safety — a price well below your value estimate — before you act.
Know the limits
A DCF works best for companies with stable, predictable cash flow. It's a poor fit for unprofitable startups or wildly cyclical businesses, and it can only be as good as your assumptions. Treat the output as a range, not a price target.
Correct!
You just finished the Time Value of Money & DCF Course — you can now turn future cash flows into a value per share and compare it to the market price.
Certificate of Completion
Time Value of Money & DCF Course
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Learn to Love Money is for educational purposes only and does not provide personalized financial, investment, tax, or legal advice. A DCF is only as good as its assumptions: small changes to growth or discount rates can swing the result dramatically, the numbers in this course (including "Example Co.") are hypothetical, and a model's output is an estimate rather than a prediction. Nothing on this page is a recommendation to buy, sell, or hold any security. Always do your own research and consult a licensed professional before making financial decisions.