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Valuation methods

Stock valuation methods

There are hundreds, if not thousands, of different ways to value shares and none of them are perfect. If any were, we would all be rich by now. The problem with any valuation method is that you have to make assumptions about future earnings, margins and so on for any business you are trying to value.​​

Discounted cash flow valuation

That being said, there are a few popular valuation methods. The discounted cash flow (DCF) valuation method is the most popular. The theory behind DCF is that the ultimate value of any business is how much free cash it generates. By using all future cash flows, discounted by the cost of capital, you can arrive at a fair value for the business. If it trades below that fair value, then it is considered capped. A higher price would suggest it is expensive. Naturally, this depends on your assumption of future cash flows.

Another popular valuation method is the Gordon Growth Model (GGM), which uses expected future dividends to determine a company’s valuation. There are other dividend models as well, but the GMM is the most widely used.​​

No valuation method is perfect. They all suffer from the risk of input data being wrong and space constraints prevent us from going into serious detail on the two above, but they are worth investigating and learning.

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