Cash Flow Discounting Must Rule the Stock Market
It is one of the first things they teach you in a Business School. Islamic banking excludes interest. However, the time value of money is a secular fact. Equity shares profit in place of usury. Everyone has to keep an eye on the calendar when cash flows are discussed. Bank notes and deposits will be worth less next year than today. Come to think of it, a year may be too long to discount money in 2008.
Computers have taken over discounting tables. Nothing has changed in the concepts of cash flow discounting. Future returns on today’s investments have Net Present Value (NPV). Every stock trade has an Internal Rate of Return (IRR) by which it can be compared with other investment alternatives. A stock analyst who advises you to hold stock without any Pay-back, NPV, and IRR specifics, is not professional.
How can you receive stock market advice when Pay-back, NPV, and IRR figures are missing? Qualitative evaluation of alternatives will do. There are other sectors. You have choices of industries in each sector. Finally, there are hundreds of stocks in each industry. Asking questions will help you find the right stocks. It is a solution to not knowing the Pay-back, NPV, and IRR of a stock recommendation.
Keep risks in mind as well. Pay-back, NPV, and IRR are guesses. Things may not happen to plan. Pick stocks with safe sensitivity profiles. Read our earlier article entitled “The Valuation Puzzle of Stock Markets” to know more about this aspect of risk management.
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