CFP - Investments: Stock Valuation and Ratio Analysis

Question 1

Dividend Discount Model

Answer 1

Provided on formula sheet

Values a company’s stock by discounting the future stream of cash flows

Question 2

Earnings Per Share (EPS)

Answer 2

Net Income - Preferred Dividends /

Outstanding Common Shares

Question 2

Price to Earnings Ratio (P/E)

Answer 2

How much an investor is willing to pay for each dollar of earnings

*Useful if stock pays no dividends

Price Per Share / EPS

Or

Price Per Share = P/E x EPS

Question 3

PEG Ratio

Answer 3

P/E Growth (PEG)

Compares a stock’s P/E Ratio to the company’s 3-5 yr growth rate in earnings

HISTORICAL

1 suggest stock is fairly valued
> 1 suggest stock is fully/overvalued

PEG = Stock’s P/E Ratio /
3-5 Yr Growth Rate in Earnings

Question 4

What is the Book Value of a Company?

Answer 4

Amount of Stockholder’s Equity in the firm

OR

How much the Company’s shareholders would receive if the firm was liquidated

If stock price > book value, may equal overvalued

Question 5

Dividend Payout Ratio

Answer 5

Relationship between the amount of earnings paid to shareholders in the form of a dividend, relative to EPS

Common Stock Dividend /
Earnings Per Share

Question 6

Return on Equity (ROE)

Answer 6

Overall profitability of a company

EPS /
SE/Share

Question 7

What is Dollar Cost Averaging?

Answer 7

Form of risk reduction

Invest the same dollar amount on a periodic basis

Question 8

What is Fundamental analysis?

Answer 8

Financial Statement Ratio analysis (liquidity, activity, profitability, common stock)

Economic data (inflation, interest rates, GDP)

Question 9

What is Technical Analysis?

Answer 9

The process of charting and plotting a stock’s trading volume and price movements

Analysis of trading volume and price movements predict future direction before fundamental analysis will

Resistance / Support levels

Believe supply and demand drive a stock price.

Question 10

What is meant by “Short Interest”?

Answer 10

The number of shares sold “short” gives insight into the future demand for a stock.

Stock that was sold short eventually needs to be repurchased.

High short interest = “pent-up” demand

Question 11

Odd Lot trading

Answer 11

< 100 shares
small investors

Question 12

Dow Theory signals what?

Answer 12

The end to a bull or bear market

Question 13

Breadth of the Market

Answer 13

Measures the number of stocks that increase in value versus the numbers of stocks that decline in value

Question 14

Advance Decline Line

Answer 14

The advance decline line is the difference between the number of stocks that closed up versus the number of stocks that decrease in value

Question 15

What is the Efficient Market Hypothesis?

Answer 15

Investors cannot consistently achieve above average market returns

Prices reflect all information that is available and change VERY QUICKLY to new information

Advocate “buy and hold”

Question 16

What is the Random Walk Theory?

Answer 16

Theory states that prices of stocks are unpredictable nut not arbitrary

Impossible to consistently achieve above-average market returns

Prices are in equilibrium

Changes in price are generated by changing needs of investors

Question 17

Efficient Market Hypothesis: WEAK FORM

Answer 17

Historical info does not help investors achieve above market returns

REJECTS technical analysis

FUNDAMENTAL ANALYSIS = above-average returns

Question 18

Efficient Market Hypothesis: SEMI-STRONG FORM

Answer 18

The semi-strong theory asserts that both historical and public information will not help investor achieve above-market returns

ONLY INSIDE INFORMATION

NO technical or fundamental analysis

Question 19

Efficient Market Hypothesis: STRONG FORM

Answer 19

Info does NOT help investors, INSIDE info does NOT help either

Stocks reflect all information and react immediately

Mutual Funds go along with the Strong Form

Question 20

January Effect anomaly

Answer 20

January tends to be a better month because of tax loss selling in NOV and DEC followed by investors getting back into the market in JAN

Question 21

Small Firm effect anomaly

Answer 21

Small Caps tends to outperform large caps

Question 22

Value Line effect

Answer 22

(1) outperform

Question 23

P/E effect

Answer 23

Stocks with a low P/E tend to outperform stocks with a high P/E

Question 24

Strategic Asset Allocation

Answer 24

Involves assessing the likely outcomes for various allocation mixes between asset classes

ACTIVE investment strategy

Question 25

Tactical Asset Allocation

Answer 25

Investor determines expected returns for asset classes, then rebalances the portfolio to take advantage of expected returns

done frequently

ACTIVE strategy