Now that we have covered the workings of discounted cash-flow (DCF) models in general and a bit about how we treat them at Morningstar, we'll dig a little deeper into how to determine fair values for stocks. In this lesson, we'll walk you through a step-by-step sample DCF model that uses the "free cash flow to equity" method. Here are the main steps to generating a per share fair value estimate with this method:
- Step 1. Project free cash flow for the forecast period.
- Step 2. Determine a discount rate.
- Step 3. Discount the projected free cash flows to the present, and sum.
- Step 4. Calculate the perpetuity value and discount it to the present.
- Step 5. Add the values from Steps 3 and 4, and divide the sum by shares outstanding.
Step 1--Project Free Cash Flow >>