103-9 Stock Valuation Concepts

Question 1

Balance Sheet

Answer 1

Snapshot of the company’s financial standing at a point in time and includes assets, liabilities, and stockholder’s equity (net worth)

Question 2

Income Statement

Answer 2

Aka profit and loss statement

Shows all income and expenses of the business owner over a period of time

Question 3

Business Statement of Cash Flows

Answer 3

Assists in the reconciliation of the business income statement to changes between 2 balance sheets

Question 4

Pro Forma Income Statement

Answer 4

Projects for the future
If the projections accurately predict a decline in business profitability, the business entity of businessowner(s) can make operational changes, such as increasing prices or decreasing costs, before the events actually occur
Created by first estimating gross profit & total expenses for the coming year or years and then accounting for the amount of taxes due on the net profit

Question 5

Book Value

Answer 5

Refers to the amount of equity available to its shareholders – the amount that the shareholders have invested in the company
Equivalent to net worth on an individual’s statement of personal financial position

Question 6

2 Primary Forms of Security Analysis

Answer 6

A) Fundamental Analysis

B) Technical Analysis

Question 7

Fundamental Analysis

Answer 7

The process of determining the FMV or intrinsic value of a security and looking for mispricings

Question 8

Market Value

Answer 8

The price of its stock as determined by investors in the secondary market

Question 9

Top-Down Fundamental Analyst

Answer 9

Begins w/ researching the overall economy and current state of the secondary market

Question 10

Bottom-Up Fundamental Analyst

Answer 10

Conducts his analysis in a manner opposite that of the top-down proponent
Aka the stock picker

Question 11

Technical Analysis

Answer 11

An attempt by analysts to determine the demand side of the supply-demand equation for a particular stock and, therefore, to predict the direction of its market price
Believe that the history of the stock price will tell the entire story of the security and that there is no need to be concerned w/ such things as ratio analysis
Sometimes called chartists

Question 12

Dow Theory

Answer 12

Based on the premise that measures of stock prices, such as averages and indexes, should move coincidentally
If prices in several indexes are increasing at the same time, a bull market is underway
If those indexes are declining simultaneously, a bear market has begun

Question 13

Odd-Lot Theory

Answer 13

Adherents of this theory believe that these investors invariably buy and sell in this manner at the wrong time

Question 14

Short-interest theory

Answer 14

High amount of short interest is considered bullish
Low amount of short interest is considered bearish
When thinking about these, taking the view of a contrarian

Question 15

Technical charting implies 3 basic assumptions

Answer 15

1) Markets discount the fundamentals
2) Markets trend
3) Trends repeat

Question 16

Expected Return

Answer 16

The return that the investor demands or expects to make and is computed by multiplying each of the investment’s possible annual returns by the probability that they will occur and adding the results

Question 17

Intrinsic Value

Answer 17

Its discounted present value based on future cash flows as determined by some form of the dividend discount model

Question 18

Constant Growth Dividend Discount Model

Answer 18

Most appropriate for valuing mature companies
Aka Gordon Model
Used to determine the intrinsic value of a stock when dividends are growing at a constant rate

Question 19

Multistage Growth Dividend Discount Model

Answer 19

Most appropriate for valuing companies in the growth phase

Assumes that the growth rate of the stock’s dividend is not constant but rather changes (either up or down)

Question 20

No-Growth (Perpetuity) Dividend Discount Model

Answer 20

Used to calculate preferred stock

When the dividend is expected to remain constant

Question 21

Discounted Free Cash Flow Model

Answer 21

Mathematically equivalent to the constant growth dividend discount model except that the current year’s dividend or next year’s dividend is replaced by FCFE on a per share basis

Question 22

Free Cash Flow to Equity (FCFE)

Answer 22

The company’s operating cash flow less its current year’s capital investments and debt repayments (including any outstanding or cumulative preferred dividends payable)

Question 23

Discounted Earnings Model

Answer 23

Aka capitalized earnings method
Discounts earnings instead of cash flows as in the dividend growth models
Simplistic method for valuing a corporation and its outstanding stock

Question 24

Market-Based Models of Relative Valuation

Answer 24

Aka ratio analysis
Used by fundamental security analysts
Price-to-earnings (P/E) ratio
Price-to-earnings dividend by growth (PEG) ratio
Price-to-free-cash-flow (P/FCF) ratio
Price-to-sales (P/S) ratio

Question 25

P/E Ratio

Answer 25

May be used to compare a company’s current market price to its earnings per share (EPS)

Question 26

Price-to-Earnings Dividend by Growth (PEG) Ratio

Answer 26

Calculated by dividing a company’s P/E ratio by the firm’s expected growth rate of earnings
Proponents of the PEG ratio believe that companies w/ a low PEG ratio (e.g. lower than 1.00) will have higher future rates of return and are good value stocks

Question 27

Price-to-Free-Cash-Flow (P/FCF) Ratio

Answer 27

How effectively the issuing company uses its free cash flow to generate earnings growth
Free cash flow is preferred over accounting earnings as a relative measure of growth because accounting earnings may be manipulated by the issuing company or may vary from industry to industry

Question 28

Price-to-Sales (P/S) Ratio

Answer 28

How much an investor is willing to pay for a specific revenue stream, in this case the company’s annual sales
Shortcoming of this ratio: it does not take into account the subject company’s net income

Question 29

Difference between Intrinsic Value (stand-alone) methods and relative value (comparison) methods

Answer 29

Intrinsic Value Methods: Constant Growth Dividend Discount Model, Multistage (Variable) Growth Dividend Discount Model, No-Growth/Perpetuity Dividend Discount Model, Discounted Free Cash Flow Model

Relative Value Methods: P/E Ratio, PEG Ratio, P/FCF Ratio, P/S Ratio