DCF Valuation Skill

Workflow Checklist

Copy and track progress:

DCF Analysis Progress:
- [ ] Step 1: Gather financial data
- [ ] Step 2: Calculate FCF growth rate
- [ ] Step 3: Estimate discount rate (WACC)
- [ ] Step 4: Project future cash flows (Years 1-5 + Terminal)
- [ ] Step 5: Calculate present value and fair value per share
- [ ] Step 6: Run sensitivity analysis
- [ ] Step 7: Validate results
- [ ] Step 8: Present results with caveats

Step 1: Gather Financial Data

Call the get_financials tool with these queries:

1.1 Cash Flow History

Query: "[TICKER] annual cash flow statements for the last 5 years"

Extract: free_cash_flow, net_cash_flow_from_operations, capital_expenditure

Fallback: If free_cash_flow missing, calculate: net_cash_flow_from_operations - capital_expenditure

1.2 Financial Metrics

Query: "[TICKER] financial metrics snapshot"

Extract: market_cap, enterprise_value, free_cash_flow_growth, revenue_growth, return_on_invested_capital, debt_to_equity, free_cash_flow_per_share

1.3 Balance Sheet

Query: "[TICKER] latest balance sheet"

Extract: total_debt, cash_and_equivalents, current_investments, outstanding_shares

Fallback: If current_investments missing, use 0

1.4 Analyst Estimates

Query: "[TICKER] analyst estimates"

Extract: earnings_per_share (forward estimates by fiscal year)

Use: Calculate implied EPS growth rate for cross-validation

1.5 Current Price

Call the get_market_data tool:

Query: "[TICKER] price snapshot"

Extract: price

1.6 Company Facts

Call the get_financials tool:

Query: "[TICKER] company facts"

Extract: sector, industry, market_cap

Use: Determine appropriate WACC range from sector-wacc.md

Step 2: Calculate FCF Growth Rate

Calculate 5-year FCF CAGR from cash flow history.

Cross-validate with: free_cash_flow_growth (YoY), revenue_growth, analyst EPS growth

Growth rate selection:

• Stable FCF history → Use CAGR with 10-20% haircut
• Volatile FCF → Weight analyst estimates more heavily
• Cap at 15% (sustained higher growth is rare)

Step 3: Estimate Discount Rate (WACC)

Use the sector from company facts to select the appropriate base WACC range from sector-wacc.md.

Default assumptions:

• Risk-free rate: 4%
• Equity risk premium: 5-6%
• Cost of debt: 5-6% pre-tax (~4% after-tax at 30% tax rate)

Calculate WACC using debt_to_equity for capital structure weights.

Reasonableness check: WACC should be 2-4% below return_on_invested_capital for value-creating companies.

Sector adjustments: Apply adjustment factors from sector-wacc.md based on company-specific characteristics.

Step 4: Project Future Cash Flows

Years 1-5: Apply growth rate with 5% annual decay (multiply growth rate by 0.95, 0.90, 0.85, 0.80 for years 2-5). This reflects competitive dynamics.

Terminal value: Use Gordon Growth Model with 2.5% terminal growth (GDP proxy).

Step 5: Calculate Present Value

Discount all FCFs → sum for Enterprise Value → subtract Net Debt → divide by outstanding_shares for fair value per share.

Step 6: Sensitivity Analysis

Create 3×3 matrix: WACC (base ±1%) vs terminal growth (2.0%, 2.5%, 3.0%).

Step 7: Validate Results

Before presenting, verify these sanity checks:

1. EV comparison: Calculated EV should be within 30% of reported enterprise_value

   • If off by >30%, revisit WACC or growth assumptions

2. Terminal value ratio: Terminal value should be 50-80% of total EV for mature companies

   • If >90%, growth rate may be too high
   • If <40%, near-term projections may be aggressive

3. Per-share cross-check: Compare to free_cash_flow_per_share × 15-25 as rough sanity check

If validation fails, reconsider assumptions before presenting results.

Step 8: Output Format

Present a structured summary including:

1. Valuation Summary: Current price vs. fair value, upside/downside percentage
2. Key Inputs Table: All assumptions with their sources
3. Projected FCF Table: 5-year projections with present values
4. Sensitivity Matrix: 3×3 grid varying WACC (±1%) and terminal growth (2.0%, 2.5%, 3.0%)
5. Caveats: Standard DCF limitations plus company-specific risks