The 5-Minute DCF: A Practical Valuation Framework

Why DCF Matters

Every serious investor needs to understand discounted cash flow valuation. It’s the gold standard of intrinsic value analysis — and it doesn’t need to be complicated.

In this guide, I’ll walk you through a practical framework that you can apply to any company in under 5 minutes for a quick sanity check.

The 5-Minute Framework

Step 1: Estimate Free Cash Flow

Start with the most recent year’s free cash flow (FCF). You can find this on any financial data platform or calculate it:

FCF = Operating Cash Flow – Capital Expenditures

For a quick estimate, use:

FCF ≈ Net Income × (1 – Reinvestment Rate)

Typical reinvestment rates:

Mature companies: 20-30%
Growth companies: 40-60%
High-growth: 60-80%

Step 2: Project Growth

Use a two-stage model:

High growth phase (5 years): Use the company’s historical growth rate or analyst consensus
Terminal growth (forever): Use GDP growth rate (2-3%)

Step 3: Determine Discount Rate

Use the company’s weighted average cost of capital (WACC):

Saudi large-caps: 8-10%
Saudi mid-caps: 10-12%
Saudi small-caps: 12-15%

Step 4: Calculate

Discount all future cash flows back to present value. The sum is your intrinsic value estimate.

Step 5: Apply Margin of Safety

Never buy at intrinsic value. Apply a 15-25% margin of safety to account for estimation errors.

Common Pitfalls

Over-optimistic growth assumptions — the most common DCF error
Ignoring capital requirements — growth requires reinvestment
Terminal value dominance — if 80%+ of your value is in terminal value, your near-term assumptions are probably wrong
Circular WACC calculations — you need the value to calculate WACC, but need WACC to calculate value

Application to Saudi IPOs

When applying DCF to Saudi IPOs, consider:

Higher risk premiums for newly listed companies
Limited trading history makes beta estimation difficult
Vision 2030 tailwinds may justify above-average growth assumptions for certain sectors
Currency stability (SAR pegged to USD) simplifies international comparisons

Next Steps

In the next post, I’ll apply this framework to a real Saudi IPO, walking through each step with actual numbers.

Have questions? Get in touch — I’m always happy to discuss valuation.