Ch 2, Module 6 Flashcards
Define “absolute value models”
assign an intrinsic value (rational value) to an asset based on the present value of its future cash flows.
Estimates of cash flows are derived and discounted based on interest rates applicable to the level of risk and required return associated with the asset and its projected cash outflows
Define “annuity”
a series of equal cash flows to be received over a number of periods
Describe a perpetuity
aka zero growth stock
aka preferred stock
when the periodic cash flows paid by an annuity last forever
pays a fixed cash flow for forever
Describe the dividend discount model
constant growth (gordon)
we have a growth rate that we believe will stay constant forever
assumes that dividend payments are the cash flows of an equity security and that the intrinsic value of the company’s stock is the present value of the expected future dividends
Define intrinsic value
the present value of its expected future cash flows
What are the types of models available for discounted cash flow analysis?
- dividend discount model = use the stock’s expected dividends as the relevant cash flows (i.e. gordon constant growth model)
- free cash flow models = including free cash flow to the FIRM and free cash flow to EQUITY. The free cash flow models discount the cash flow left over by the firm after satisfying certain required obligations
- residual income models = represent the income left over after the firm satisfies the investor’s required return
Relative Valuation models do what
use the value of comparable stocks to determine the value of similar stocks
i.e. price multiples
P/E ratio
most widely used multiple whne valuing equity securities
earnings are a key driver of investment value (stock price)
Once calculated, the P/E ratio can be multiplied by anticipated future earnings in order to determine the current stock price
Define trailing P/E
use EPSo
Define PEG ratio
a measure that shows the effect of earnings growth on a company’s P/E assuming a linear relationship between PE and growth.
generally stocks that have lower PEG ratios are mroe attractive t oinvestors than stock that have higher PEG ratios
Describe price to sales
less manipulation when it comes to sales (as opposed to earnings)
sales are also always positive so this multiple can be used even when EPS is negative
also not as volatile as the PE ratio which includes the effect of financial and operating leverage
Describe Price to CF
cash flow is harder for ocmpanies to manipulate than earnings
p/cf is a more stable measure than pe
empirical research has shown that changes in a company’s pcf ratios over time are positvely related to a company’s lt changes to stock price
