When to use a Simplified DCF method - Value = Cash Flow * Multiple, where the Multiple = 1 / (Discount Rate - Growth Rate).

 

Conclusion

Yes, the DCF process can be powerfully simplified into a single formula: Value = Cash Flow * Multiple, where the Multiple = 1 / (Discount Rate - Growth Rate).

This simplification is excellent for developing intuition and performing rapid, preliminary assessments. However, it should be seen as a starting point for thought, not the finish line for valuation. The full DCF model's purpose is to explicitly account for the unique forecast period that the simple rules of thumb must ignore.

https://myinvestingnotes.blogspot.com/2025/11/valuation-cheat-sheet-brian-feroldi.html

The full DCF process can be simplified and approximated using rules of thumb, which is very common for quick sanity checks, back-of-the-envelope calculations, and initial screening of investments.

These simplifications almost always focus on the Terminal Value, as it is the most dominant part of the valuation.

Here are the most common and useful simplifications and rules of thumb:

1. The Perpetuity Growth Model (A Simplified DCF)

This is the method used in the original example for the Terminal Value. You can use it as a single-stage DCF to value a company as a whole, assuming stable growth forever. This is a massive simplification that ignores the initial high-growth period.

The Formula (Gordon Growth Model):
Value = FCF₀ * (1 + g) / (r - g)
Where:

• FCF₀ = Current Free Cash Flow

• g = Perpetual Growth Rate

• r = Discount Rate (WACC)

Application to Our Example:
If we ignored the 5-year high-growth phase and assumed the company's $100 FCF would grow at 2% forever with a 10% discount rate, the valuation would be:

• Enterprise Value = [$100 * (1 + 2%)] / (10% - 2%) = $102 / 0.08 = $1,275

This is reasonably close to the detailed model's Enterprise Value of $1,446, and it's calculated in one step. The difference ($171) is the value the detailed model ascribes to the 5 years of 5% growth.

2. The Earnings Power Value (EPV) - A Zero-Growth DCF

This is an even more conservative simplification. It assumes the company cannot grow and will simply generate its current level of cash flow in perpetuity. This sets the growth rate g = 0.

The Formula:
Value = FCF₀ / r

Application to Our Example:

• Enterprise Value = $100 / 10% = $1,000

This gives you a very solid "floor" value for a stable, no-growth business. Any value significantly above this implies the market is pricing in future growth.

3. The Rule of Thumb: The "1 / (r - g)" Multiple

The core of the perpetuity model is the multiple 1 / (r - g). You can pre-calculate this multiple for different assumptions to quickly value any company.

Discount Rate (r)	Growth Rate (g)	Multiple (1 / (r-g))	Quick Valuation (on $100 FCF)
8%	2%	16.7x	~$1,670
9%	2%	14.3x	~$1,430
10%	2%	12.5x	~$1,250
10%	3%	14.3x	~$1,430
12%	2%	10.0x	~$1,000

How to use it: Find the multiple that best fits the company's risk (r) and long-term prospects (g). Multiply it by the company's current FCF. In our example, the 12.5x multiple gives us $1,250, which is a quick approximation.

4. Relating DCF to Market Multiples (The Implied P/E)

A DCF model implicitly implies a fair P/E ratio. For a company with no growth (g=0), the fair P/E ratio is approximately 1 / r.

• If the discount rate is 10%, the fair P/E is 10x.

• If the discount rate is 8%, the fair P/E is 12.5x.

When you add growth, the justified P/E expands. This is a powerful mental model for understanding whether a market multiple is reasonable based on the company's cost of capital and growth potential.

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When to Use These Simplifications (And Their Major Pitfalls)

Use them for:

• Quick sanity checks: Is a stock price in the right ballpark?

• Screening investments: Quickly compare the theoretical value of multiple companies.

• Explaining concepts: They make the drivers of value (cash flow, growth, and risk) very clear.

Be Wary of their Pitfalls:
These simplifications are dangerous if used as a primary valuation tool because they gloss over critical details:

1. They Ignore the Forecast Period: The most valuable (or risky) part of a business is often the next 5-10 years. A high-growth tech company cannot be valued with a perpetuity model alone.

2. They Are Hyper-Sensitive to r and g: The difference between r-g is everything. If g is too close to or exceeds r, the model explodes and gives an infinite value, which is nonsensical. (The perpetual growth rate must be less than the discount rate and the nominal GDP growth rate).

3. They Assume Instant Stability: They assume the company is already in a "stable state," which is rarely true.

4. They Mask the Impact of Debt: The single-stage model gives Enterprise Value. You still need to subtract Net Debt to get to Equity Value, a step that is easy to forget in a quick calculation.

Conclusion

Yes, the DCF process can be powerfully simplified into a single formula: Value = Cash Flow * Multiple, where the Multiple = 1 / (Discount Rate - Growth Rate).

This simplification is excellent for developing intuition and performing rapid, preliminary assessments. However, it should be seen as a starting point for thought, not the finish line for valuation. The full DCF model's purpose is to explicitly account for the unique forecast period that the simple rules of thumb must ignore.