Discounting

Discounting is expressing cash received in the future in today's money because inflation erodes the value of money over time.

One way to value a share is to add up the cash flows you expect to receive from it in the future and then 'discount' them.

Discounting is expressing cash received in the future in today's money because inflation (for which the compensation as an investor is an interest rate on cash) erodes the value of money over time.

So, for example, £100 received now and invested at an annual interest rate of, say, 5% would be worth £105 in one year, £110.25 in two years (100 x 1.05 x 1.05) and £115.76 in three years.

Similarly, the discounted value (today's equivalent) of £115.76 due in three years is £100. Or, given the choice between £100 now and £115.76 in three years, assuming annual interest rates of 5%, you should be indifferent as the two are worth about the same on a like-for-like basis.

See Tim Bennett's video tutorial: Five ways companies can cook cash flow.

Recommended

Modern monetary theory (MMT)
Glossary

Modern monetary theory (MMT)

Modern Monetary theory, or MMT, has become popular on the left, both in the UK and abroad. (Wags say that it stands for "magic money tree".) 
21 Sep 2020
Price to sales ratio
Glossary

Price to sales ratio

A company's market cap divided by the company's annual sales (or revenue) gives us the price/sales ratio.
28 Aug 2020
Too embarrassed to ask: what is a p/e ratio?
Too embarrassed to ask

Too embarrassed to ask: what is a p/e ratio?

Find out how to use the price/earnings ratio (p/e ratio for short) – a useful starting place for investors looking to value a company.
26 Aug 2020
Stock split
Glossary

Stock split

A stock split increases the number of a corporation's issued shares by dividing each existing share.
21 Aug 2020

Most Popular

The electric-car bubble could get an awful lot bigger from here
Renewables

The electric-car bubble could get an awful lot bigger from here

The switch to electric cars is driving a huge investment bubble. But that’s not necessarily a bad thing, says John Stepek. Fortunes will be made and l…
24 Sep 2020
Can Rishi Sunak’s winter plan save the UK economy?
UK Economy

Can Rishi Sunak’s winter plan save the UK economy?

With his Winter Economic Plan, chancellor Rishi Sunak is hoping to support the economy through the dark months ahead as restrictions tighten again. Jo…
25 Sep 2020
The rising dollar is proving bad news for most other assets – will it last?
Investment strategy

The rising dollar is proving bad news for most other assets – will it last?

Precious metals, stocks and pretty much every other asset has taken a tumble as the US dollar strengthens. Dominic Frisby looks at how long this trend…
23 Sep 2020