It is not uncommon to see stock prices gyrate wildly during earnings season. A small earnings beat and the stock goes up 10% or even 20%. An earnings miss and the stock is down double digits after hours.
Are these stock price movements justified? Has the intrinsic value of the stock really changed that much? In this article, I look at how a change in assumptions about a company’s cash flow can affect the intrinsic value of the stock.
I take a look at what effects changing assumptions to a company’s cash flow have on the intrinsic value of the stock.
When long-term assumptions are slashed
Let’s start by analysing a stock that has its long-term assumptions slashed. This should have the biggest impact on intrinsic value compared to just a near-term earnings miss.
Suppose Company A is expected to dish out $1 in dividends every year for 10 years before it closes down in year 10 and liquidates for $5 a share....