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ValuFocus Investing: A Cash-Loving Contrarian Way to Invest in Stocks by William F. Mahoney, Rawley Thomas

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Chapter 12

Our Approach

A good place to start in analyzing the fundamental differences in our approach is to compare earnings and cash-based models.

Is the stock market oriented toward earnings or cash flow? That's a question that's been somewhat of a puzzle for investors and company executives. The simple answer is both. The market is complex and investors use numerous methods in their efforts to grow returns above their investments and hopefully outperform the averages of others collectively.

There are many investors using an economic approach focusing more on cash flow, but there is a bigger legion of investors using an approach focusing more on earnings that are derived mainly from accounting practices. Completing the stock-investing universe, there also are investors with models that combine cash flow and earnings metrics. These investors also weight their impact on portfolio decisions variously. And, of course, there are the many investors who apply multifactor models and the big crowds that follow passive quantitative, indexing, and hedging strategies.

Investors generally agree that the most fundamental valuation model is discounted cash flow. Variations, add-ons, and refinements include dividend discount, economic profit, economic value added, and cash flow return on investment.

We've covered the earnings-based and multifactor models, and so we'll focus now on the economic, cash-based models as a way of moving into our particular process.

DCF says that the value of an investment ...

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