InvestorQ : How to estimate the future cash flow of any stock?

# How to estimate the future cash flow of any stock?

2 years ago
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To estimate future cash flows of any stock, there is a technique called Discounted Cash Flow model (DCF), under this the current price of a share is used to calculate the target price of any stock, by applying appropriate discount rate, in accordance with company’s risk.

Discounted Cash Flow Model:

This approach involves estimating how much free cash flow the company will produce for investors, say over a 5 years period, and then calculating how much the investors need to pay for that stream of free cash flows based on an appropriate discount rate. This definitely sounds easy but it has some challenges involved, and above all top most challenge is to calculate discount rate, which depends on the risk-free interest rate, the company’s cost of capital and the risk it's stock faces.

But, there’s always a solution to a problem, so to tackle the challenges of all those calculations, one must work-out with what he has rather than an estimation, use current or prevailing parameters.

Formula to calculate Present value of future cash flow is as follows:

Present value = [CF1 / (1+k)] + [CF2 / (1+k)2] + ... [TCF / (k-g)] / (1+k)n-1]

That’s fairly complicated, but let’s define the terms:

CF1 - The expected cash flow in year one

CF2 - The expected cash flow in year two

TCF - The “terminal cash flow,” or expected cash flow overall. This is usually an estimate, as calculating anything beyond five years or so is guesswork.

k - The discount rate, also known as the required rate of return

g - The expected growth rate

n - The number of years included in the model

The above formula can be used to calculate the total present value of cash flow which then is to be divided by the number of shares outstanding to find out the per share future stock price.

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