We have already seen in this blog several articles about valuation methods in fundamental analysis. For the moment, we are focusing on analyzing discounted cash flows, both from a theoretical point of view As with practical examples. In this article we will analyze the cash flow discount rate, its utility and the value that we must choose according to the type of company that we are going to analyze.
What is the discount rate for?
The discount rate is an essential part of valuation by discounting cash flows. It is the discount rate that we will apply to calculate the current value of future cash flows, so the valuation we obtain will depend on this, which is a critical factor when selecting the companies in which we are going to invest if we use this valuation method.
What discount rate to apply to stock valuations?
To choose the discount rate, there are several formulas. In my opinion, the discount rate should be chosen based on the risk of the company that we are going to analyze. We must ask ourselves the following question:
"What return should I demand from this company taking into account the risks inherent in this investment?"
It is essential in these cases to know how to calibrate the risk of the company. To do this, we must attend to factors such as its relative indebtedness and its competitive situation. The higher the risk, the higher the return we demand of the investment should be. I advise being prudent at the beginning, since it is better to err on the side of caution than on risk.
The discount rates I apply to cash flow discounts
Each person must choose the discount rates they deem appropriate. In my case, these are the discount rates that you use as a guide:
- Very low risk companies: 7%
- Low risk companies: 10%
- Medium risk companies: 12%
- High-risk companies: More than 15%
As I have already said, calibration is essential and each investor must adapt the discount rate according to their own criteria.
If you have any questions, you can share them in the comments and I will try to answer them as soon as possible.