Intrinsic value is the cornerstone of value investing. It is the answer to the question: what is this business actually worth, independent of what the market says it is worth today? Every buy and sell decision in Buffett's framework is anchored to this number.
The standard method for calculating intrinsic value is the Discounted Cash Flow (DCF) model. Buffett has called it "the only rational way to determine the attractiveness of an investment relative to alternative investments." This guide walks through exactly how it works — step by step, with a worked example.
"Intrinsic value is the discounted value of the cash that can be taken out of a business during its remaining life." — Warren Buffett, 1994 Owner's Manual
The DCF model is built on one foundational insight: future cash flows are worth less than present cash flows, because money available today can be invested and earn a return. A dollar you receive in 10 years is worth less than a dollar you receive today — and the exact discount depends on two things:
Intrinsic value is simply the sum of all future free cash flows, each discounted back to today's equivalent value.
Most practical DCF models used for stock valuation use two stages to handle the fact that companies grow quickly in the near term and then slow as they mature.
In the first stage, you project the company's free cash flow for each of the next 10 years, applying an estimated annual growth rate. You then discount each year's projected FCF back to present value using the discount rate.
No company grows at a high rate forever. After year 10, you assume the business grows at a slow, sustainable rate in perpetuity — typically 2–4%, close to long-run GDP growth. This "terminal value" is calculated using the Gordon Growth Model and then discounted back to present value.
The starting point for the model is the company's current free cash flow per share. This comes from the company's cash flow statement: operating cash flow minus capital expenditures. We use a trailing twelve months (TTM) figure, normalised where possible to exclude one-off items.
Read more in our free cash flow guide.
This is the most important and most uncertain input. The growth rate estimate is typically derived from:
Buffett applies a conservatism discount: he typically projects growth well below what analysts forecast. His logic: if the business is truly great, a conservative estimate still yields an attractive value; if the business fails to meet aggressive projections, the margin of safety protects against the shortfall.
Conservative growth estimates matter here: a company growing FCF at 50% per year cannot sustain that rate — and assuming it does produces a DCF output that is not a realistic estimate of fair value. Applying sensible, sustainable growth projections is more important than matching the most optimistic analyst forecast.
The discount rate represents the return you require to invest in this business instead of an alternative. It is usually the company's Weighted Average Cost of Capital (WACC) — a blend of the cost of equity and the after-tax cost of debt, weighted by their proportion in the capital structure.
Cost of equity is typically derived from the Capital Asset Pricing Model (CAPM):
A stock with a beta of 1.2 and a 4.5% risk-free rate would have a cost of equity of approximately 11.7%. If the company also has debt at 5% interest and a 25% tax rate, the WACC blends these at their respective weights in the capital structure.
This is the long-run sustainable growth rate applied to the terminal value. It should never exceed the long-run nominal GDP growth rate — if it did, the company would eventually become larger than the entire economy. A rate of 2.5–3.5% is standard for a stable, mature business.
Consider a hypothetical company ("CompanyX") with the following characteristics:
| Year | Projected FCF | Discount Factor | Present Value |
|---|---|---|---|
| 1 | $5.40 | 0.909 | $4.91 |
| 2 | $5.83 | 0.826 | $4.82 |
| 3 | $6.30 | 0.751 | $4.73 |
| 4 | $6.80 | 0.683 | $4.64 |
| 5 | $7.35 | 0.621 | $4.56 |
| 6–10 | $7.94–$10.80 | 0.565–0.386 | ~$18.90 |
| Sum of Stage 1 PV | $42.56 | ||
| Terminal Value (PV) | $63.40 | ||
| Intrinsic Value Estimate | ~$105.96 | ||
With a current price of $80 and an intrinsic value of approximately $106, the margin of safety is about 25% — right at Buffett's threshold for a high-confidence investment.
The DCF result is highly sensitive to small changes in inputs — especially the growth rate and discount rate. A 1% change in the discount rate can shift intrinsic value by 15–30%. This is why Buffett applies a large margin of safety: he knows his inputs are estimates, not facts, and wants to be right even if the future is somewhat worse than he expects.
The appropriate way to use a DCF estimate is as a range of plausible values, not a single precise number. If the model suggests intrinsic value is between $90 and $120 under different reasonable assumptions, and the stock is trading at $65, you have a meaningful safety margin even in the pessimistic scenario.
Our automated model runs a two-stage DCF calculation for every S&P 500 company every market day. We use trailing financial data sourced from public filings, apply conservative growth assumptions, and calculate WACC on a per-company basis using current market data. The output — an intrinsic value estimate and a margin of safety percentage — appears in every Pro subscriber alert alongside the full Buffett Score breakdown.
