Economics Stack Exchange Archive

Price of an (unwanted) asset?

I’ve been thinking about capital assets such as stocks, and how their price is determined. On one side, models such as the Discounted Cash Flow (DCF) allow valuing a stock as a function of its future financial benefits (cash flows, consisting of dividends and/or capital gains). This is irrespective of any supply and demand for the asset. But on the other hand, if we ignore this model’s valuation, and look only at the Supply vs. Demand model of pricing and assume that the supply of stocks is finite (i.e. the firm will not increase its capitalization), the price is entirely determined by demand for the stock.

  1. Do both of these models give the same valuation? This would then mean that demand (and therefore price, like in the DCF model) is entirely determined by future cash flows.
  2. What happens, then, if an asset with low DCF valuation is in “abnormally” high demand (leading to a market price above DCF valuation), or conversely, an asset with high DCF valuation is in “abnormally” low demand (leading to a market price below DCF valuation)? Could one model contradict the other? Which one would be “right”?

Answer 1246

There is no "right" price. There are many ways of valuing an asset, and generally they will give different answers. A commonly used metric for stocks is the P/E ratio, but there are many others. Successful investors are those who buy assets that later rise in price, and sell assets that later fall in price.

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