When discounted determine current stock price

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when discounted, determine current stock price. Numerous large-sample empirical stud- ies provide evidence consistent with a linkage between earnings and prices. A subset of these studies finds a link between earnings changes and excess stock returns. In general, studies find excess annual returns of around 10-25% for earnings increases, and 10-25% negative returns for earnings decreases. It is no wonder that investors, analysts, and others devote so much time and effort to forecasting. 20% 15% VI c: ~ 10% a:; •.. ~ 5% 2l )( Q) 0% ~ i "5 -5% E ::J U_ 10 % --------------------- ~ -15% -20% -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 Months relative to annual earnings announcement STEP 4-COMPANY VALUATION When we embark on financial statement analysis, we are motivated by the need to make a finan- cial decision. This could be from an external standpoint such as whether to buy or sell shares as an investor or from an internal standpoint such as evaluating a potential acquisition or change in scope of operations. All financial decisions involve valuation at some level. In making these decisions, we attempt to predict the future. The need for predictions arises from our desire to determine what a company is worth (Step 4). The key to good valuation estimates is accurate forecasts of future payoffs. And, the key to forecasting is having a good understanding of where the firm currently is and the business environment in which it competes. One method for determining value is to directly examine the worth of the company's assets and liabilities. However, in most cases, we instead think of the worth of a company as the cur- rent value of expected payoffs. In Modules 12 to 14, we describe how to compute value using dividends, cash flows, and earnings as the payoffs. We often hear the adage "cash is king," which some then interpret as cash being best for valuation instead of, say, dividends or earnings. How- ever, like earnings, cash reporting is subject to managerial biases and accounting limitations-no more, no less. Yet, there are situations where cash or earnings or dividends can work better for valuation purposes. We must develop the skills to understand where those situations are and where one, or a combination of different metrics, is best for valuation. Module 15 tackles market-based valuation, which is probably the most frequently used valu- ation technique in the world today. At first glance, this method appears not to require the analysis performed in Steps 1, 2, and 3, as it generally utilizes market multiples determined from compa- rable firms. However, this is deceiving. Understanding where the company operates, where the company currently is, and where the company is going also drives valuation using multiples. That
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Module 1 I Framework for Analysis and Valuation 1-24 .our financial analysis influences the choice of market multiple, the choice of comparables, and interpretation of the valuation estimate.
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