Discounted cash flow (DCF) is a calculation designed to evaluate a company’s current value by projecting its future free cash flows, operating costs, revenues, and growth. But these values are easier to accurately predict with larger, more firmly established companies that have steady growth histories on which to base these projections. It’s substantially harder to make these forecasts for smaller, newer companies that have not yet had significant exposure to seasonal or economic cycles.
Not surprisingly, DFC calculations are easier to predict in industries where capital expenditure levels are relatively consistent over time, such as utilities, banking, and energy sectors like oil and gas. But even with established companies, it’s tough to accurately predict operating costs and revenues beyond one-to-two years in the future. Furthermore, any minor early forecasting errors become exponentially amplified over time. For this reason, investors should take DCF projections beyond 10 years with a grain of salt.