DCF Valuation Skill

Workflow Checklist

Copy and track progress:

DCF Analysis Progress:
- [ ] Step 1: Gather financial data
- [ ] Step 2: Calculate FCF growth rate
- [ ] Step 3: Estimate discount rate (WACC)
- [ ] Step 4: Project future cash flows (Years 1-5 + Terminal)
- [ ] Step 5: Calculate present value and fair value per share
- [ ] Step 6: Run sensitivity analysis
- [ ] Step 7: Validate results
- [ ] Step 8: Present results with caveats

Step 1: Gather Financial Data

Call the get_financials tool with these queries:

1.1 Cash Flow History

Query: "[TICKER] annual cash flow statements for the last 5 years"

Extract: free_cash_flow, net_cash_flow_from_operations, capital_expenditure

Fallback: If free_cash_flow missing, calculate: net_cash_flow_from_operations - capital_expenditure

1.2 Financial Metrics

Query: "[TICKER] financial metrics snapshot"

Extract: market_cap, enterprise_value, free_cash_flow_growth, revenue_growth, return_on_invested_capital, debt_to_equity, free_cash_flow_per_share

1.3 Balance Sheet

Query: "[TICKER] latest balance sheet"

Extract: total_debt, cash_and_equivalents, current_investments, outstanding_shares

Fallback: If current_investments missing, use 0

1.4 Analyst Estimates

Query: "[TICKER] analyst estimates"

Extract: earnings_per_share (forward estimates by fiscal year)

Use: Calculate implied EPS growth rate for cross-validation

1.5 Current Price

Call the get_market_data tool:

Query: "[TICKER] price snapshot"

Extract: price

1.6 Company Facts

Call the get_financials tool:

Query: "[TICKER] company facts"

Extract: sector, industry, market_cap

Use: Determine appropriate WACC range from sector-wacc.md

Step 2: Calculate FCF Growth Rate

Calculate 5-year FCF CAGR from cash flow history.

Cross-validate with: free_cash_flow_growth (YoY), revenue_growth, analyst EPS growth

Growth rate selection:

• Stable FCF history → Use CAGR with 10-20% haircut
• Volatile FCF → Weight analyst estimates more heavily
• Cap at 15% (sustained higher growth is rare)

Step 3: Estimate Discount Rate (WACC)

Use the sector from company facts to select the appropriate base WACC range from sector-wacc.md.

Default assumptions (Japanese market):

• Risk-free rate: ~1.0-1.5% (JGB 10-year yield)
• Equity risk premium: 5-6%
• Cost of debt: 0.5-2.0% pre-tax (~0.4-1.4% after-tax at ~30% Japanese corporate tax rate)

Calculate WACC using debt_to_equity for capital structure weights.

Reasonableness check: WACC should be 2-4% below return_on_invested_capital for value-creating companies.

Sector adjustments: Apply adjustment factors from sector-wacc.md based on company-specific characteristics.

Step 4: Project Future Cash Flows

Years 1-5: Apply growth rate with 5% annual decay (multiply growth rate by 0.95, 0.90, 0.85, 0.80 for years 2-5). This reflects competitive dynamics.

Terminal value: Use Gordon Growth Model with 1.0-1.5% terminal growth (Japan nominal GDP growth proxy).

Step 5: Calculate Present Value

Discount all FCFs → sum for Enterprise Value → subtract Net Debt → divide by outstanding_shares for fair value per share.

Step 6: Sensitivity Analysis

Create 3×3 matrix: WACC (base ±1%) vs terminal growth (0.5%, 1.0%, 1.5%).

Step 7: Validate Results

Before presenting, verify these sanity checks:

1. EV comparison: Calculated EV should be within 30% of reported enterprise_value

   • If off by >30%, revisit WACC or growth assumptions

2. Terminal value ratio: Terminal value should be 50-80% of total EV for mature companies

   • If >90%, growth rate may be too high
   • If <40%, near-term projections may be aggressive

3. Per-share cross-check: Compare to free_cash_flow_per_share × 15-25 as rough sanity check (Japanese market PER: ~15x average; growth 20-30x, value 8-12x)

4. PBR sanity check: Verify fair value implies PBR > 1.0x. If below 1.0x, flag TSE governance reform pressure as potential upside catalyst. Companies trading below PBR 1.0x face regulatory pressure to improve capital efficiency.

If validation fails, reconsider assumptions before presenting results.

Note: All monetary amounts should be expressed in JPY (millions). Discount rate references JGB yields, not US Treasury.

Step 8: Output Format

Present a structured summary including:

1. Valuation Summary: Current price vs. fair value, upside/downside percentage
2. Key Inputs Table: All assumptions with their sources
3. Projected FCF Table: 5-year projections with present values
4. Sensitivity Matrix: 3×3 grid varying WACC (±1%) and terminal growth (0.5%, 1.0%, 1.5%)
5. Caveats: Standard DCF limitations plus company-specific risks