How The Discounted Cash Flow (DCF) Finds The Best Stock Investments
The discounted cash flow (DCF) analysis is like a crystal ball into the future of stock prices. Although no one can truly predict stock prices, the DCF method helps determine which companies will preform the best going forward. Whether an investor wants to find the next great internet company or short specific sectors in the stock market, the DCF is a valuable tool for any stock market expert.
A discounted cash flow (DCF) analysis is an analysis of the cash flow generating ability of an investment going into the future. Unfortunately, future predictions have risks, so future cash flows must be discounted into today's dollars in order to have a risk-adjusted value for that investment. When creating future predictions of inflation, credit and other risk factors, a discounting factor must be applied.
In order to put a company's forecasts into present value terms, an inflation rate is assumed for the future time period being analyzed. Usually, this amounts to looking at the historical inflation rates over the last ten or twenty years to determine an average rate that is then applied to future projections.
Imagine you have a project where sales were $100 this year and will be $120 dollars next year. This increase sounds great until an investor examines the inflation rate and discovers that it will increase by 15% next year. The real rate of increase in sales is only $5 and not $20, because of inflation. The discounted cash flow analysis adjust for inflation risk.
The discounted cash flow (DCF) analysis first measures the amount of cash flow that a business will generate. If that cash flow is a net positive when discounted into current dollars, then the investment is worth pursuing. For investors, if the discounted cash flow amount is greater than the current value of the company, then the investment is undervalued and could be bought; the opposite is also true.
The discounted cash flow (DCF) is an invaluable tool for any investor. No investment can be made without a proper analysis of the risk and rewards and profit potential of a project or investment; however, taking the time to complete a DCF model is the big hurdle for most investors. Visit http://www.wikiwealth.com/dictionary:discounted-cash-flow to get a head start.
Article Source: FxTradingStock.com
About the Author
Looking to find the best tools to invest in stocks, then see WikiWealth.com's discounted cash flow analysis. www.wikiwealth.com is the address for thousands of free DCF analysis reports.
by: Paul Market
Total views: 37
Word Count: 383
Date: Fri, 29 Oct 2010
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