What is a common limitation of the DCF method?

The DCF method's common limitation is its reliance on subjective assumptions. When conducting a DCF analysis, analysts must project future cash flows and estimate the appropriate discount rate. Both of these components can vary significantly based on the analyst's perspective and the information available, leading to different outcomes for the valuation. Factors like growth rates, margins, and the selection of the discount rate can heavily influence the results, making them somewhat subjective.

This reliance on assumptions means that even small changes in inputs can result in substantial differences in the calculated present value. Therefore, while DCF is a critical tool for valuing businesses based on their projected cash flows, its effectiveness can be compromised by the inherent uncertainty and subjectivity involved in making these estimations. This aspect makes it essential for analysts to approach DCF valuations with a sense of prudence and to clearly communicate the assumptions made during the process.