Stock Valuation
Stock valuation is the mechanism of calculating theoretical values of companies and their stocks. The major aim of these methods is to predict future market prices. In general, potential market prices and therefore to profit from price movement such as stocks that are judged undervalued with reference to their theoretical value are purchased. Stocks that are judged overvalued are sold, in the anticipation that undervalued stocks will rise in value while overvalued stocks will fall.
Stock valuation based on basic principle aims to render an approximation of their intrinsic value of the stock based on fore castings of the future profitability and cash flows of the business. The underlying analysis may be augmented by market criteria i.e what the market will pay for the stock, without any essential opinion of intrinsic value. These can be compounded as predictions of future cash flows or profits together with what will the market pay for these profits. These can be seen as demand and supply sides that underlies the supply and drives the market demand for stock.
Stock valuation is not a forecasting but it is a convention, which serves to make easier investment and assure that stocks are liquid.
The most profound stock valuation method is the discounted cash flow (DCF) method also known as income valuation method. It offers discounting of the profits i..e earnings, cash flows or dividends of the stock and contribute to the stockholder in the foreseeable future assumptions and a final value on disposal. The discounted rate normally comprise a risk premium which is normally based on the capital asset pricing model.
A Delaware court ruled on advantageous inputs to exercise in discounted cash flow analysis in a conflict between a company and shareholders over the fair value of the stock in July 2010. In this case the shareholders' model rendered value of $139 per share and the company's model renders $89 per share. Contended inputs comprise the the equity risk premium, beta and terminal growth rate.
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