Expectations Investing

• Companies can compute earnings using alternative, equally accept-

able accounting methods.

Discounted cash-flow models, and stock prices, account for the time

value of money: A dollar today is worth more than a dollar a year from

now because we can invest today’s dollar to earn a return over the next

year. So when a company invests, it must compare its return to those of

alternative, equally risky investment opportunities. This opportunity

cost, or cost of capital, is the discount rate for a discounted cash-flow

model. Earnings calculations, in contrast, ignore this opportunity cost.

In a discounted cash-flow model, value increases only when the

compan ...