From Theory to Practice
You've learned what DCF is conceptually. Now let's actually do one. We'll value Apple (AAPL) step by step, showing every calculation and assumption along the way.
Step 1: Get the Financial Data
First, gather Apple's key financials from their latest annual report (10-K):
| Metric | Value | Source |
|---|---|---|
| Revenue | $383B | 10-K FY2023 |
| Free Cash Flow | $111B | Cash Flow Statement |
| FCF Margin | 29% | FCF Γ· Revenue |
| FCF Growth (5yr avg) | 12% | Historical trend |
| Shares Outstanding | 15.5B | Balance Sheet |
Step 2: Project Future Cash Flows
We project FCF for the next 10 years. Assumptions: 12% growth for years 1-5, slowing to 8% for years 6-10 (large companies grow slower over time).
| Year | Growth Rate | Projected FCF |
|---|---|---|
| Year 1 | 12% | $124B |
| Year 2 | 12% | $139B |
| Year 3 | 12% | $156B |
| Year 5 | 12% | $196B |
| Year 7 | 8% | $228B |
| Year 10 | 8% | $288B |
Step 3: Choose a Discount Rate
The discount rate reflects your required return. For Apple, we'll use 10% (a common rate for stable, large-cap stocks). Higher risk = higher discount rate.
Step 4: Calculate Terminal Value
After year 10, we assume Apple grows at 3% forever (roughly GDP growth). Terminal Value = Year 10 FCF Γ (1 + growth) Γ· (discount rate - growth rate) = $288B Γ 1.03 Γ· (0.10 - 0.03) = $4.24 trillion.
Step 5: Sum and Divide
Add up all discounted cash flows (years 1-10) plus the discounted terminal value, then divide by shares outstanding to get intrinsic value per share.
$3.7 trillion Γ· 15.5 billion shares = approximately $239 per share. If Apple is trading below this, it may be undervalued.
Sensitivity Analysis: What If We're Wrong?
| Discount Rate \ Growth | 10% FCF Growth | 12% Growth | 15% Growth |
|---|---|---|---|
| 8% Discount | $298 | $335 | $389 |
| 10% Discount | $212 | $239 | $278 |
| 12% Discount | $158 | $179 | $209 |
The valuation ranges from $158 to $389 depending on assumptions. This is why Buffett says, "I'd rather be approximately right than precisely wrong."
Common DCF Mistakes
π‘ Avoid These Errors
- Using overly optimistic growth rates β be conservative, not hopeful
- Ignoring the discount rate sensitivity β small changes = huge valuation swings
- Projecting too far into the future β 10 years is enough; beyond is guesswork
- Treating the output as precise β DCF gives a range, not a number
- Skipping the sanity check β does the valuation make common sense?
π‘ DCF Tutorial β Key Summary
- 5 steps: gather data β project FCF β choose discount rate β terminal value β sum it up
- Apple example: ~$239/share intrinsic value (at 10% discount, 12% growth)
- Sensitivity analysis is crucial β show a range, not a single number
- DCF is a framework for thinking, not a precision tool
- Always do a sanity check: does your answer make sense?