How to Value a Stock with DCF: A Step-by-Step Guide (2026)
Price is what you pay. Value is what you get.
A stock's price tells you what the market thinks today. A discounted cash flow (DCF) model tells you what the business might be worth based on the cash it can generate. The gap between the two is where your investment case lives.
A DCF won't give you the "right" answer. It forces you to write down your assumptions about growth, margins and risk, then shows you what price those assumptions justify. If you can't defend the inputs, you can't defend the buy.
This guide walks through every step, with a worked example you can follow on a napkin.
The idea in one formula
A business is worth all the cash it will ever produce, adjusted for the fact that money later is worth less than money now.
Value = Σ FCFₜ ÷ (1 + r)ᵗ + TV ÷ (1 + r)ᴺ
- FCFₜ is the free cash flow in year t: cash left after running the business and investing in it.
- r is the discount rate: the return you require for the risk you take.
- N is the forecast period, usually 5 or 10 years.
- TV is the terminal value: everything the business earns after year N, squeezed into one number.
That's the whole model. Everything else is choosing the inputs well.
How to build a DCF in seven steps
- Start from the latest revenue. Use the last full year from the company's Financials or 10-K. This is your base.
- Forecast revenue growth. Pick a growth rate for each year of the forecast. Check it against the company's history and analyst estimates. Fast growth rarely lasts, so let it fade toward the economy's growth rate by the final year.
- Turn revenue into free cash flow. Apply a margin to get operating profit, take off tax, then subtract capital spending and working-capital needs. A shortcut is an FCF margin: free cash flow as a % of revenue, based on the company's track record.
- Set the discount rate. Most models use WACC, the weighted average cost of capital. It blends the cost of equity (from the risk-free rate, beta and the market risk premium) with the after-tax cost of debt. Riskier businesses get a higher rate.
- Calculate the terminal value. Assume cash flow keeps growing at a modest rate forever after the forecast. The common formula is final-year FCF × (1 + g) ÷ (r − g), where g is long-term growth, typically 2–3%.
- Discount everything to today. Divide each year's cash flow, and the terminal value, by (1 + r) raised to the year number. Add them up to get enterprise value.
- Get to a per-share fair value. Subtract net debt (or add net cash) to get equity value, then divide by shares outstanding. Compare the result with today's price.
Worked example: Example Co
Example Co is a made-up company, so the math is easy to follow. It had $1,000M of revenue last year, turns 15% of revenue into free cash flow, holds $200M of net cash and has 100M shares. The stock trades at $30.
Our assumptions: growth of 10%, 10%, 8%, 6% and 4% over five years, a 9% discount rate and 2.5% long-term growth.
| Year | Revenue ($M) | FCF at 15% ($M) | Discount factor at 9% | Present value ($M) |
|---|---|---|---|---|
| 1 | 1,100.0 | 165.0 | 0.9174 | 151.4 |
| 2 | 1,210.0 | 181.5 | 0.8417 | 152.8 |
| 3 | 1,306.8 | 196.0 | 0.7722 | 151.4 |
| 4 | 1,385.2 | 207.8 | 0.7084 | 147.2 |
| 5 | 1,440.6 | 216.1 | 0.6499 | 140.4 |
| Total | 743.1 |
- Terminal value. 216.1 × 1.025 ÷ (0.09 − 0.025) = $3,407.6M in year 5. Discounted to today: 3,407.6 × 0.6499 = $2,214.7M.
- Enterprise value. 743.1 + 2,214.7 = $2,957.9M.
- Equity value. 2,957.9 + 200 net cash = $3,157.9M.
- Fair value per share. 3,157.9 ÷ 100M shares = $31.58, about 5% above the $30 price.
Notice that the terminal value makes up 75% of the enterprise value. Most of a DCF's answer sits in the years you can't see. That's why the next section matters.
Small inputs, big swings
Change two inputs by one or two points and Example Co's fair value moves from $22.75 to $55.41 a share. Same company, same cash flows.
| Discount rate ↓ / Long-term growth → | 1.5% | 2.0% | 2.5% | 3.0% | 3.5% |
|---|---|---|---|---|---|
| 7% | $38.29 | $41.28 | $44.95 | $49.53 | $55.41 |
| 8% | $32.60 | $34.64 | $37.05 | $39.93 | $43.46 |
| 9% | $28.44 | $29.90 | $31.58 | $33.54 | $35.86 |
| 10% | $25.26 | $26.34 | $27.57 | $28.98 | $30.60 |
| 11% | $22.75 | $23.58 | $24.51 | $25.55 | $26.74 |
At a 9% discount rate the stock looks fairly priced. At 8% it looks cheap; at 10% it looks expensive. So don't treat a DCF as one number. Treat it as a range, and ask which assumptions you'd bet on.
Common DCF mistakes
- Growth that never slows. 20% a year for ten years is rare. Fade growth toward 2–4% by the end of the forecast.
- Long-term growth above the economy. A terminal rate above long-run GDP growth means the company eventually becomes bigger than the economy.
- A discount rate picked to fit the answer. Set the rate before you see the result, based on risk, not on the price you want.
- Ignoring dilution and debt. Use the diluted share count and subtract debt. Stock-based compensation is a real cost.
- Margins out of thin air. Anchor margins to the company's history and its peers. If you assume expansion, know why.
- One scenario only. Build a bear, base and bull case. The spread tells you as much as the midpoint.
Run it in Foremetrics without a spreadsheet
Every stock page in Foremetrics has a Custom DCF tab with the company's financials already filled in. You change the assumptions; the model updates as you go.
- Revenue Growth and EBITDA Margin drive the cash-flow forecast (steps 2 and 3).
- WACC is built from Beta, Cost of Equity, Cost of Debt, Risk-Free Rate, Market Risk Premium and Tax Rate (step 4).
- Long-Term Growth sets the terminal value (step 5).
- CapEx and D&A as % of Revenue control how much profit turns into free cash.
- The output is an Estimated Fair Value next to the current price, with the upside or downside in %.
To avoid the one-scenario trap, open the Projection tab. It lays out Bear, Base and Bull cases for revenue, net income, EPS and price, with CAGR, on one chart. Then check Estimates to see how your Base Case compares with the analyst price target consensus, and Peer Comparison to sanity-check margins and growth against competitors.
FAQ
What is a DCF in simple terms?
It estimates what a company is worth today by adding up the cash it's expected to generate in the future, discounted for time and risk.
What discount rate should I use?
Most investors use WACC. For large, stable companies it often lands around 7–10%; riskier or smaller companies warrant more. Use a rate you'd accept as your required return.
How many years should I forecast?
Five years suits mature companies. Ten years helps for fast growers whose growth needs time to settle down.
Why is the terminal value so large?
Because it covers every year after the forecast. In our example it was 75% of the total. If yours is above 80–85%, your forecast may be too short or your long-term growth too high.
Does a DCF work for every company?
It works best for businesses with positive, fairly predictable cash flows. For banks, early-stage companies or cyclical firms at a peak, combine it with other methods like P/E or price-to-book.
What's a margin of safety?
A discount to fair value you require before buying, often 15–30%, to cover errors in your assumptions.
Value a stock you already own
Pick one holding. Open its Custom DCF, set the growth and margin you actually believe, then look at the Bear case in Projection. If the fair value surprises you, you've learned something the price chart couldn't tell you.
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Example Co is hypothetical and its figures are for illustration only. Not financial advice. For informational and educational purposes only.
