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Stocks IV: Reverse valuation

All discounted cash flow (DCF) models require the analyst to forecast cash flows and to estimate their proper discount rate. Estimating cash flows, however, is a mix of art and science, with a fair share of sorcery. But there is a way around. We can reverse-engineer market prices to infer the market’s expectations for the growth rate of a company’s cash flows. We can then evaluate the plausibility of those expectations, and finally assess the value of the company. Read on, it’s less difficult than it sounds.

What is this all about?

The idea behind reverse valuation is to expose the assumptions ...

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