If you have spent any time considering investment opportunities, then the term “DCF valuation” has probably come up at least once. It is an important part of how many people choose to invest and for predicting how well an investment would generate cash flow.
But what is DCF valuation, and why does it matter? If you are looking to invest, then you need to know how this valuation metric can be useful to you.
What is DCF Valuation?
In simple terms, Discounted Cash Flow (DCF) valuation is a financial model that focuses on future cash flows. The idea is to estimate the future cash flow of a company or other investment, ignoring the initial cash investment in favor of the potential earnings it could generate.
This general idea allows you to estimate the future value of an investment before it gains more value, allowing you to invest in something with an understanding of its (estimated) increase in value over time. While these predictions are not always entirely accurate, they are still a good way to gauge the potential value of an investment.
How is Discounted Cash Flow Calculated?
A basic DCF calculation is a fairly straightforward process, although the formula can be tricky.
DCF is equal to the sum of the cash flow in each period of time used for the estimate, divided by one plus the discount rate matched to each period's power.
In other words, an estimate is made for every single period of time used within the time range you choose, all using the same basic formula. This is meant to give you a decent estimate of how your investment will change in value and can be used as a measurement for a specific investment and a way to compare different investments and assets against one another.
Why is DCF Value Useful?
One of the main benefits of Discounted Cash Flow valuation is the fact that it focuses on future value rather than the immediate intrinsic value of an investment. While intrinsic value is still a useful thing to measure, DCF focuses on how that value will change in the future – which means the time after you make an investment.
Using metrics like DCF provides an easy way to estimate the potential growth of something that you invest in. While this is just an estimate, it is based on hard data taken from the current value of the asset and can be a good way to compare different investment options that probably will not see massive upsets in their value or growth in the near future.
Platforms like Alpha Spread are a great way to get hold of this relative valuation information consistently, ensuring that you have a wider pool of value information to rely on when you are comparing different investment opportunities..
If you are somebody who is heavily considering quite a wide range of places to invest, it is a good idea to rely on metrics like DCF value as a solid starting estimate. While estimates are never completely accurate, DCF can be an invaluable way to get an idea of how different investments should increase in value over time.