When hunting for cheap stocks to buy, you should always factor in how much cash a business might make over time. A discounted cash flow (DCF) model does just this — analysts use the model to estimate future cash flows and then ask: “What’s it worth in today’s money”?
If the answer is much higher than the current share price, the stock might be trading below fair value.
Essentially, it calculates the cash a company is expected to generate each year, then ‘discounts’ it back using a required return, say 10%-12%.
Think of it like asking how much you’d pay today for £1,000 a year from now. If the market price is way below that present value, either the market’s too gloomy or the model’s too optimistic.
In many cases, it’s a mix of both — which is why you need a margin of safety. But how does that look in practice?
Example 1: Pharos Energy
Pharos Energy (LSE: PHAR) is a small oil & gas producer operating in Vietnam and Egypt. Some DCF estimates suggest the shares trade around 61% below fair value, with the average 12-month price target eyeing a 111% gain.
Other valuation metrics back this assessment. It has a forward price-to-earnings (P/E) ratio of 5.27 and EV/EBITDA of 1.51 (both well below average).
Income-wise, Pharos offers a dividend yield of around 5% backed by strong cash flows. However, volatile oil price swings mean the payout ratio has bounced around over the years.
Analysts expect earnings to grow significantly, with some forecasts expecting 50% a year as production and pricing improve.
The catch is obvious: profits depend heavily on commodity prices and stable operations in places like Egypt and Vietnam, so there’s both geopolitical and oil-price risk.
Example 2: Future
Future (LSE:FUTR) is a digital media group behind online magazines and specialist brands across tech, gaming, finance and more. The share price has been hammered due to AI’s effect on digital ads, now down roughly 80% from its peak over five years.
Yet the business still brings in decent cash. In 2025, it reported revenue down about 6% to roughly £739m. However, it kept an EBITDA margin around 30% and generated close to 100% free cash flow conversion.
Debt looks manageable at about 1.1 times EBITDA, and the firm has been able to raise its dividend and run buybacks. Companies don’t do that unless cash flow is solid.
Using a DCF model, analysts reckon the shares could be trading at 78% below fair value.
Still, there is a genuine risk from AI. If the company can’t adapt to meet the changing landscape, that strong cash flow might soon dry up. In other words, it’s cheap partly because the future is uncertain.
Why these might appeal to UK investors
For UK value investors willing to stomach the bumps, Pharos and Future are worth considering at these cheap prices. They exhibit how DCF-based undervaluation can flag opportunities where sentiment looks too gloomy versus long-term cash flow power.
But just because a share’s cheap today, there’s no guarantee the price will go up in the future. Building a diversified portfolio of growth, income and value shares can help reduce risk of losses in one area.
