Stock Valuation
Value stocks using the Dividend Discount Model, free cash flow models, and relative valuation multiples. These three approaches form the core toolkit for equity analysis in both academic and professional settings. Knowing when to apply each method is as important as the math itself.
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Study Tips
- ✓Match cash flow type to discount rate
- ✓Growth rate must be less than discount rate in perpetuity
- ✓Sanity-check outputs against market price
- ✓Use multiples as a cross-check on DCF
Common Mistakes to Avoid
Setting the terminal growth rate above the economy's long-run growth rate, which implies the firm becomes larger than GDP. Also confusing FCFF (discount at WACC) with FCFE (discount at cost of equity) leads to wrong enterprise values.
Stock Valuation FAQs
Common questions about stock valuation
DDM works best for mature, dividend-paying firms with stable payout policies. DCF is more flexible and works for any firm with forecastable cash flows, including companies that do not pay dividends.
It depends entirely on the industry, growth rate, and risk. A tech company might trade at 30x earnings while a utility trades at 15x. Compare to sector peers, not an absolute number, and check whether you are using trailing or forward earnings.
Terminal value captures all cash flows beyond the explicit forecast period, which for a going concern represents decades of future earnings. It often accounts for 60-80% of total enterprise value, which is why terminal growth rate and exit multiple assumptions are so sensitive.
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