How To Invest Lesson 4 - Using Discounted Cash Flow (DCF) Analysis to Value Stocks

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In this WealthLift video lesson, you will learn:

• What is "Discounting”?

• How do I use discounting to find undervalued stocks?

• What is a margin of safety?

Lesson 4: Using Discounted Cash Flow Analysis to Value Companies and Stocks


Lesson 4: What is Discounting?

• $1 today is worth more than $1 promised tomorrow

• Promise of money in the future means you get no interest on the money in the meantime & have the uncertainty of whether you’ll actually get the money

• A promise of $1000 a year from now has a present value of less than $1000.



Discount Rate

Similar to an interest rate you demand for getting money in the future instead of now

Discount Rate = Risk-Free Interest Rate + Risk Premium

Discount Rate = 4% Risk-Free Interest Rate + 7% Risk Premium

= 11% Discount Rate



We can calculate present value of any money promised in the future

Present Value = Promised Amount ÷ (1 + Discount Rate)No. of Years

Present Value = $1000 ÷ (1 + 0.11)5

= $593.45

Discount Rate


Lesson 4: How do I use discounting to find undervalued stocks?

• By buying a stock, you are being promised future payments in the form of earnings by the company

• Fair stock price is equal to sum of all the present values of all future payments

• Using discounting of future earnings to price a stock is known as discounted cash flow analysis, or DCF


Lesson 4: How do I use discounting to find undervalued stocks?

• Adding present values of all future earnings of a company is a complicated calculation

• Instead, you can use the WealthLift DCF Valuation calculator to calculate a fair stock price

• Calculator found on article lesson page of WealthLift Lesson 4


Lesson 4: What is a Margin of Safety?

Benjamin Graham, American economist and professional investor

“ … the best book about investing ever written."


Lesson 4: What is a Margin of Safety?

• No one can predict the future perfectly

• Estimates of future company profits are at best an educated guess

• Included a margin of safety in stock valuations

Margin of Safety = ($50 Valuation – $40 Stock Price) ÷

$40 Stock Price

= 25% Margin

Graham only invested with a 40-60% Margin


In the next WealthLift video lesson, you will learn:

• How do brokerage commissions and fund management costs affect my investment returns?

• What are ETFs and how can they minimize my trading costs?

• How should I choose a stock brokerage?

Congratulations – Lesson 4 Completed

Education

How To Invest Lesson 4 - Using Discounted Cash Flow (DCF) Analysis to Value Stocks