DCF Done Right: Bull, Base and Bear
"Price is what you pay. Value is what you get." — Warren Buffett
A discounted cash flow (DCF) model estimates what a business is worth today by projecting its future cash and discounting it back. Three inputs do most of the work:
- The near-term trend in free cash flow margins.
- Revenue growth over the next five to ten years.
- The terminal multiple or long-run growth rate at the end of the forecast.
The third input is where most analysts go wrong — they assume the good times last too long. The fix is simple: run three versions — bear, base and bull. Only invest when even the bear case still offers an acceptable return. That conservative bear case is your margin of safety.
Illustrative example: Alphabet (Google), 2015
At around US$550 a share, a cautious bear-case model implied roughly US$480 of value, the base case about US$900, and the bull case around US$1,400. With the downside close to the price and the upside well above it, the range of outcomes was skewed favourably. The method — testing a deliberately pessimistic case — matters more than these particular numbers.
Educational only — not financial, tax, or investment advice, or a recommendation to take any particular course of action. Any names, figures, and examples illustrate a principle and are historical or simplified; past performance is not a reliable indicator of future results. Rules, tax treatment, and published figures change over time and may not reflect current policy. Wealth Diagnostics provides education and tools for financial advisers and their clients — seek licensed advice for your own circumstances before making any financial decision.