Discounted cash flow is the most powerful valuation technique in the analyst's toolkit. It is also the most abused. The mechanics are simple: forecast free cash flow, discount at cost of capital, sum, add terminal value, done. The judgement, which is the hard part, hides in five decisions that most models get wrong.
Mistake one: the terminal value that swallows the model
In a typical DCF with a 10-year explicit forecast horizon, 65-80% of the valuation comes from the terminal value. This is not a bug — it is the mathematical consequence of a perpetuity assumption. But it means that the entire valuation is, in practice, a bet on the terminal growth rate and the terminal margin.
The fix: always run the DCF with terminal value at 60% of enterprise value as a benchmark. If your model produces a terminal value share above 80%, something is wrong with your explicit forecast — either it's too short, or the FCF is growing too slowly across the explicit horizon.
Mistake two: WACC calculated with the wrong beta
Beta calculated from two years of daily returns is noise. Beta calculated from five years of weekly returns is noise plus survivorship bias. The academic Modigliani-Miller framework says to relever peer betas; most models don't bother.