Discount rate
Also called Required return, Cost of capital.
The return you require, which is what makes a dollar in five years worth less than a dollar today.
Present value = future cash / (1 + discount rate) ^ years
Often estimated as the weighted average cost of capitalWhat it means
Money now is worth more than money later, because it can be put to work and because later is uncertain. The discount rate is the price of that difference, and it is the single most consequential number in any valuation.
It is not a market fact. It is a decision about what return makes the risk worth taking, which is why two people can value the same company correctly and disagree by half.
Worked example
$274m of free cash flow expected in five years, discounted at 9%.
- 11.09 ^ 5 = 1.5386.
- 2274 / 1.5386 = 178.
$178m in today's money — 35% less than the face amount.
Every example in this glossary describes the same imaginary company, so the figures join up as you move between metrics.
How investors read it
- Higher risk deserves a higher rate. A stable utility and a young biotech should not be discounted at the same number.
- Test the sensitivity rather than defending a figure. Moving the rate by a point and watching the valuation move by a fifth is the useful exercise.
- It should sit above what a government bond pays, and by an amount that reflects the risk of the specific business.
Where it misleads
- There is no correct value, and the standard method for estimating one depends on beta, which is a measure of past price movement rather than of business risk.
- Applying a single rate to every year assumes risk is constant over time, which it is not.
- Small changes compound: the effect on the terminal value is far larger than on the forecast years.
How Materiality uses it
An editable input to the Valuation tab, defaulting to 10% and constrained to a range between 6% and 20%. It must also exceed the terminal growth rate by at least a point, because as the two converge the terminal value heads for infinity and the model would return a number with no meaning. That constraint is enforced rather than advised.
The full methodology covers where the figures come from, how the statements are normalised, and what is deliberately left unadjusted.
Work it out yourself
Related metrics
Intrinsic value
What a business is worth based on the cash it can produce, rather than on what it is currently priced at.
Terminal growth
The rate a business is assumed to grow at forever, after the years anyone actually forecast.
Beta
How much a stock has tended to move when the market moves.
Margin of safety
The gap between what you pay and what you think it is worth — the room to be wrong.
A metric on its own is a number without a business attached to it. Materialitycomputes these from a company's own SEC filings, several years of them at once, and explains what the pattern means rather than leaving you to hold fifteen definitions in your head.