Question

Compare and contrast the Earnings per Share approach and the Discounted Cash flow approach to value securities in the stock market.

Answer 1

Discounted cash flow method to value the security will be focusing on discounting the cash flows which are available to the business in the future at the present, in order to arrive at net present value and then deriving the value of the share out of it.

Earning per share approach will be taking into consideration, earnings which have been reported by the company in the books of accounts and then finding out the proper valuation of the company.

Discounted cash flow is always based upon the valuation of the cash flows whereas Earning per share will be always based upon the valuation of the profits of the company.

Discounted cash flows has a larger applicability than the Earning per share approach because not every company will be reporting profits and only those companies who are reporting profits can be valued through Earning per share method.

Discounted cash flow is always taking into account the risk adjustment and other macro factors whereas Earning per share is just focusing on the profitability and it has a limited approach.

So, these are the major differences between the Earning per share approach and discounted cash flow approach in order to value the securities in the market and discounted cash flow is a highly preferable method because it is able to value almost all the companies in the market who are reporting cash and cash is always the king not the profits in contemporary world.