Valuation Models And The Value Of The Stock Essay

2152 Words Sep 9th, 2014 9 Pages
Valuation models are used to disclose (reveal) the mispricing of securities. These models are exhibited(used) by fundamental(financial) analysts, who use information regarding the current and potential profitability of a company to measure its fair market value. Based on the results of analysis, financial analysts can then make informed, accurate decisions on whether to sell, hold or buy a stock.
There are alternative measures on how to value a company. Quantitative tools such as the dividend discount model and the relative valuation method are most commonly used to measure the ongoing value of the firm and emphasizing some of their limitations (Bodie, Kane, & Marcus, 2011).

Dividend discount model

The dividend discount model is the simplest model to use when valuing a stock, where the value of the stock is derived from the value of the expected future dividend stream. The simplest model to use when valuing equity(a stock) is the dividend discount model, where the value of the stock is the present value of (the expected dividend stream) expected dividends on it. The value of a firm’s future cash flows must be discounted back to its present value at an applicable discount rate to find the firm’s value. The dividend discount model involves quite a few assumptions about the firm’s dividend payments, future interest rates as well as the growth patterns (Damodaran, n.d.).
The assumptions laid out were: The growth rate is constant and will continue growing for an infinite…

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