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DCF Analysis: Pros & Cons of DCF

  1. DCF Analysis: The Forecast Period & Forecasting Revenue Growth
  2. DCF Analysis: Forecasting Free Cash Flows
  3. DCF Analysis: Calculating the Discount Rate
  4. DCF Analysis: Coming Up with a Fair Value
  5. DCF Analysis: Pros & Cons of DCF
  6. DCF Analysis: Conclusion

DCF analysis is widely used by investment bankers and other finance professionals. Even though determining a company’s DCF is a fairly lengthy and involved process, some retail investors like to perform their own calculations rather than rely on the word of analysts. Whether you calculate DCF on your own or take the word of analysts, it’s important to consider the method’s strengths and weaknesses.

Pros

  • DCF offers the closest estimate of a stock’s intrinsic value. It’s considered the most sound valuation method if the analyst is confident in his or her assumptions.
  • Unlike other valuation methods, DCF relies on free cash flows, considered to be a reliable measure that eliminates subjective accounting policies.
  • DCF isn’t significantly influenced by short-term market conditions or non-economic factors.
  • DCF is particularly useful when there’s a high degree of confidence regarding future cash flows.

Cons

  • DCF valuation is very sensitive to the assumptions/forecasts made by the analyst. Even small adjustments can cause DCF valuation to vary widely – which means the fair value may not be accurate.
  • DCF tends to be more time-intensive compared with other valuation techniques.
  • DCF involves forecasting future performance, which can be very difficult, especially if the company isn’t operating with 100% transparency.
  • DCF valuation is a moving target: If any company expectations change, the fair value will change accordingly.

DCF Analysis: Conclusion
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