chap 8 Flashcards
Stock valuation:
Investors attempt to resolve the question of whether and to what extent a stock is under- or over-valued by comparing its current market price to its intrinsic value
Common-size income statement:
takes every entry found on an ordinary income statement or balance sheet and converts it to a percentage (i.e., divides every item on the statement by sales)
Average market multiple:
Average P/E ratio of all the stocks in a given market index, like S&P 500 or DJIA
- Indicates general state of the market.
- Gives idea of how aggressively the market, in general, is pricing stocks.
- All else equal, the higher P/E ratio the more optimistic the market.
- Increases in P/E ratio do not necessarily indicate a bull market; P/E ratio spiked in 2009 because earnings were very low due to the recession
Relative P/E multiple:
investors calculate this to evaluate a stock’s P/E performance relative to the market; calculated by dividing a stock’s P/E by a market multiple.
Valuation:
process by which an investor determines the worth of a security keeping in mind the tradeoff between risk and return
A stock could be a worthwhile investment candidate if:
The expected rate of return equals or exceeds the return we feel is warranted given the stock’s risk.
–The justified price (intrinsic worth) is equal to or greater than the current market price.
Required Rate of Return:
the return that an investor requires to compensate them for the investment’s risk
Dividend valuation model (DVM):
approach which holds the value of a share of stock as a function of its future dividends
Three versions of the DVM:
Zero-growth model: assumes dividends will not grow over time.
Constant-growth model: assumes dividends will grow by a constant rate over time.
Variable-growth model: assumes rate of growth in dividends will vary over time
