dcf
Value is discounted cash
The rule
A business is worth the cash it will hand its owners over its whole life, brought back to today's value. Nothing more, nothing less.
Where it flips
But this cash method is the right frame and a shaky sum. Small changes in growth or the discount rate swing the answer wildly. The idea keeps your thinking honest. The spreadsheet should not be trusted down to the last paisa.
Williams boiled value down to one idea. A company is worth the future cash it returns to owners. Each rupee is shrunk a little for the wait and the risk. Every multiple, every rule of thumb, is just a short way of saying this same sum. A reader who keeps the cash-flow anchor in mind can spot when a shortcut has quietly drifted away from it.
A worked example
A retailer trades at forty times earnings and the story is 'quality compounder'. Traced back to cash, that price only holds if the chain hands owners rising cash for two decades. The shortcut hid an assumption the reader can now check. [illustrative]
How to spot it
- ·a valuation multiple used with no link back to cash
- ·value defended by feeling rather than the owner's cash flows
- ·the wait and the risk left out of the reasoning
John Burr Williams · The Theory of Investment Value