Valuation 101

How to Value a Stock

Valuation 101: There is only one true way to value stocks (or any financial assets) — as has been stated by the top investing minds over the ages:

The value of an asset equals the present value of the future cash flows available to the owner(s) of the asset.

There are two ways to measure the PV of future cash flows:

  1. Intrinsic value approach: enter your forecast into a DCF model and determine your target price
  2. Expectations quantification approach: reverse engineer the future cash flows required to justify the market price.

I prefer option #2 because it relieves me of the onus of predicting the future. Instead, I use my dynamic discounted cash flow model to quantify the expectation in every stock we cover. Then, I assess those expectations for reasonableness.

I am not interested in market expectations that may be close to reasonable. I focus on the extremely high and low expectations: Buy low expectations and sell/short abnormally high expectations.

That is the best way to make money in the stock market over any meaningful amount of time.

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