Will the stock market collapse again? | Personal finance


# 4: know a decent estimate of the value of what you own

Ultimately, stocks are nothing more than fractional ownership stakes in companies. Yes, their market prices can go up or down dramatically in a very short period of time, but in the long run stocks are tied to the cash-generating capacity of the companies behind those stocks.

Using the discounted cash flow model and reasonable projections for the future of the business, you can estimate what that fair value would be. You can easily adjust your assumptions for a more aggressive or more pessimistic growth future as well, to get a feel for a range of potential values. You can then compare your model with the market price and use it to inform your buy, sell or hold decisions.

If the price of a business you own is so high by the market that even your most aggressive estimates for its future can’t keep up, then it might be a good idea to sell it. On the flip side, if a business you own is available at such a low price that even your pessimistic estimate is above market price, you might want to consider buying even more.

The beauty of the discounted cash flow model is that it can help you make those buy / sell / hold decisions regardless of what the market is doing as a whole. As a result, it can help you prepare for a crash by determining which businesses to consider selling and investing in the event of a crash by determining which are the best deals worth buying.


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