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Danielson, M.G. Stock Valuation and Investor Expectations. Encyclopedia. Available online: https://encyclopedia.pub/entry/59340 (accessed on 15 December 2025).
Danielson MG. Stock Valuation and Investor Expectations. Encyclopedia. Available at: https://encyclopedia.pub/entry/59340. Accessed December 15, 2025.
Danielson, Morris G.. "Stock Valuation and Investor Expectations" Encyclopedia, https://encyclopedia.pub/entry/59340 (accessed December 15, 2025).
Danielson, M.G. (2025, December 08). Stock Valuation and Investor Expectations. In Encyclopedia. https://encyclopedia.pub/entry/59340
Danielson, Morris G.. "Stock Valuation and Investor Expectations." Encyclopedia. Web. 08 December, 2025.
Peer Reviewed
Stock Valuation and Investor Expectations
This is a peer-reviewed entry published in Encyclopedia Journal, full entry can be found at 10.3390/encyclopedia5040203

Stock valuation models can be used to guide the investment decisions of institutions or individuals. In the traditional approach, the investor will use a valuation model to calculate a stock’s intrinsic value as a function of the estimated future cash flows the firm will distribute to its shareholders. The investment decision will hinge on how the estimated intrinsic value compares to the current stock price. This approach is appropriate when the investor has access to the detailed company-specific information required to forecast future cash flows. In an alternative approach, the process is reversed, and stock valuation models can be used to identify the cash flow expectations supporting a firm’s current stock price. Depending on whether or not these expectations are reasonable—in light of current and expected firm-specific, industry, and macroeconomic conditions—the investor can decide whether to buy, sell, or hold the stock. This approach is appropriate for external investors who do not have access to detailed company-specific information. This entry discusses the uses and limitations of the most prominent stock valuation models when used in the traditional framework, and explains how to identify and evaluate the expectations embedded within a current stock price.

stock valuation growth expectations
In theory, a stock price is the present value of the future cash flows the company is expected to pay shareholders. In practice, however, the process of first identifying the future cash flows and then calculating the present value of a lengthy (or infinite) cash flow stream can be unwieldy. To sidestep these challenges, stock valuation models make simplifying assumptions about the growth pattern future cash flows will follow, streamlining the process of estimating a firm’s stock price. These models can then be used by institutional and individual investors in one of two different, but related, ways.
In the standard textbook approach, students are taught how to use stock valuation models in a linear fashion. The investor must first estimate the model’s inputs (e.g., cash flow growth rates and the required return), before using the model to calculate the stock’s intrinsic value [1][2]. If this value is greater than the current stock price, the investor should buy the stock. If the intrinsic value is less than the current stock price, the investor should either sell the stock or, at a minimum, refrain from buying it. This approach can be appropriate when the investor has access to the detailed company-specific information required to forecast future cash flows (e.g., an institutional investor when pricing an IPO or valuing a company prior to a merger or divestiture).
An alternative approach reverses the process. Starting with the current stock price, a stock valuation model can be used to characterize the cash flow expectations supporting that price. In particular, is the firm expected to invest in positive net present value projects in the future? If so, for how many years must the firm make those investments? And, how profitable must these new projects be? Depending on whether or not these expectations are reasonable—in light of current and expected firm-specific, industry, and macroeconomic conditions—the investor can decide whether to buy, sell, or hold the stock [3][4][5]. This approach is appropriate for external investors (either institutional or individual) who do not have access to detailed company-specific information, and can help those investors quickly identify stocks that are potentially over- or underpriced.
This entry identifies the most prominent valuation models and summarizes their uses and limitations as methods to estimate a stock’s intrinsic value. The entry then shows how to quantify the expectations supporting a current stock price and explains how an investor can evaluate the reasonableness of those expectations.

References

  1. Ross, S.A.; Westerfield, R.W.; Jordan, B.D. Fundamentals of Corporate Finance; McGraw-Hill: New York, NY, USA, 2025.
  2. Brealey, R.A.; Myers, S.C.; Allen, F.; Edmans, A. Principles of Corporate Finance; McGraw-Hill: New York, NY, USA, 2025.
  3. Danielson, M.G. A Simple Valuation Model and Growth Expectations. Financ. Anal. J. 1997, 54, 50–57.
  4. Mauboussin, M.J.; Rappaport, A. Expectations Investing; Columbia University Press: New York, NY, USA, 2021.
  5. Danielson, M.G. Investor Expectations and the AIRR Model. Eng. Econ. 2023, 68, 211–229.
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Subjects: Business, Finance
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Online Date: 08 Dec 2025
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