A value investor can gain a lot from Discounted Cash Flow Analysis of a company. For first time investors Discounted Cash Flow Analysis will tell the investors that whether the present market value of shares are overpriced or underpriced.
Not only in terms of judgment on market price of shares but Discounted Cash Flow Analysis also gives the idea to the investors that “what factor affects the companies market price of stocks”. The factors like sales turnover, profit margins etc.
In addition to above the Discounted Cash Flow model also considers the risk free interest rates prevailing in the market, the cost of capital the company pays by borrowing debts.
Considering all of the above factors, a particular stocks is valued so as to avoid purchase of any overvalued stocks.
In order to do the Discounted Cash Flow Analysis we must calculate the “Free Cash Flow” from the companies’ Financial Statements. Free Cash flow is the extra cash in hand from companies operations. This extra cash is the income after paying all cash expenses.
This extra/free cash is used by the company increase shareholders value. If shareholders value is increasing, it has direct implication on market price of stock. This is the reason why “Free Cash Flow” is so important in Discounted Cash Flow Analysis of a share.
Let’s see how we can calculate Free Cash Flow from Companies Financial Statements.
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