1. Discounted Cash Flow Valuation
What is it: In discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset.
Philosophical Basis: Every asset has an intrinsic value that can be estimated, based upon its characteristics in terms of cash flows, growth and risk.
Fundamental Analysis derives those cash flows from the underlying, or fundamental, operations of the business.
Discounted cash flow valuation is geared for assets that derive their value from the cashflows that they are expected to generate - most businesses and financial assets fall into this category.
The inputs needed for all discounted cash flow models - cash flows, discount rates and asset life - are the same, though the ease with which they can be estimated may vary from asset to asset.
When we use discounted cash flow valuation, we are assuming that we can estimate intrinsic value and that market prices can deviate from intrinsic values. We also assume that prices will revert back to intrinsic value sooner or later - this is why a long time horizon is a prerequisite. 1

2. Why use Fundamental Analysis?
January 2000: Internet Capital Group was trading at $174.
“Valuation is often not a helpful tool in determining when to sell hypergrowth stocks”, Henry Blodget, Merrill Lynch Equity Research Analyst in January 2000, in a report on Internet Capital Group.
There have always been investors in financial markets who have argued that market prices are determined by the perceptions (and misperceptions) of buyers and sellers (inefficiencies of the market), and not by anything as prosaic as cash flows or earnings.
Perceptions do matter, but they are not everything.
Asset prices cannot be justified by merely using the “bigger fool” theory.

3. “Irrational Exuberance”
January 2000: Internet Capital Group was trading at $174.
January 2001: Internet Capital Group was trading at $ 3.

4. Mistaken notions of how the market works?
January 2000: Internet Capital Group was trading at $174.
January 2001: Internet Capital Group was trading at $ 3.

5. Damodaran has resources online
His spreadsheets are not always as helpful as you might want…
An example of a valuation summary he did in 2008

6. What Damodaran’s valuation summary looks like: September 2008

7. What Damodaran’s valuation summary looks like: October 2008

8. Bear in mind, these were a summary
Bear in mind, these were a summary. We will ultimately want something more detailed for a working document.

9. DCF Methods Compared FCFE//Ke – Equity cash flow method
FCFF//WACC – Corporate valuation method
FCFF//Ku – Adjusted present value method (APV)

10. DCF: Equity cash flow method

11. DCF: Corporate valuation method

12. DCF: Adjusted present value method (APV)

13. DCF results compared In theory, the methods produce equivalent results
This is rarely the case in the real world…

14. What does the DCF Model look like?

15. What does the DCF Model look like?

16. What does the DCF Model look like?