Chapter 4 - Stock Valuation and Ratio Analysis Flashcards
Gordon Growth Model; Expected Rate of Return
- Formulas are same except restructured
- Gordon Growth: Values company’s stock by discounting future CF’s
**Exam Tip:
- If required RoR decreases, then stock price increases
- If expected dividend increases, then stock price increases
Price-Earnings Ratio (P/E Ratio)
- How much investor willing to pay for each $ of earnings
- Useful in valuing stock if no dividends are paid
P/E = Price per Share/EPS
- OR -
Price per Share = P/E x EPS
*know - Formula not provided
Dividend Payout Ratio (DPR)
- Relationship between amount of earnings paid relative to EPS
- The higher the DPR, the more mature a company. May also indicate that the dividend may be reduced in future years.
Exam Tip: KNOW formula - not provided
Return on Equity (ROE)
- Measures overall profitability of company
- Direct relationship between - ROE, dividends, and earnings
ROE = EPS/Stockholder Equity per Share
**Exam Tip: KNOW formula - not provided
Dividend Yield
Dividend Yield = Dividend / Stock Price
- the annual dividend as a % of stock price
Fundamental Analysis vs Technical Analysis
Fundamental Analysis: ratio analysis of financial statements (BS & Income Statement) and economic data (inflation, interest, GDP, etc.). Believes stock price performance is driven by financial performance of the firm.
Technical Analysis: historical data; charting and plotting stock movements - predict future direction of stock prices way before Fundamental Analysis. Believes supply and demand drive stock price.
Tools for their analysis:
- Charting:
- Market volume:
- Short Interest: # of shares sold short giving insight for future demand
- Odd Lot Trading: trades less than 100 shares
- The Dow Theory: signals an end to a bull or bear market. Does not indicate when, it just confirms that it HAS ended.
- Breadth of the Market: measures # of stocks that increase in value vs. # that decline
- Advance Decline Line: difference between # of stocks that closed up # that decreased in value
*Exam Tip: Do not need to know definition of each Technical Analysis tool BUT know what technicians consider in analysis and what Fundamental Analysts consider.
Efficient Market Hypothesis (EMH)
- Investor cannot consistently achieve above-average market performance
- Stock prices follow a “Random Walk”
- Investors believe in passive investing
Random Walk Theory: stocks are unpredictable but not arbitrary
3 Forms of the Efficient Market Hypothesis:
1) Weak Form: asserts historical information will NOT help investors; reject Technical Analysis & asserts Fundamental Analysis will lead investor to achieve above-average returns
2) Semi-Strong Form: asserts both historical & public info will NOT help investors; rejects BOTH Technical & Fundamental Analysis; ONLY insider/private information will lead to above-average returns
3) Strong Form: asserts historical, public, and private information will NOT help investor; asserts stock prices reflect all available info & react immediately to any new info; NOTHING will enable market to be out performed on a consistent basis
*Exam Tip: There will be questions surrounding EMH. Know what 3 forms support and reject.
EMH: Price Reflects: Adv through:
Weak Historical Price Data Fund. Analysis & Insider info
Semi-Strong Public Info Insider Info
Strong All Info NONE
Passive vs Active Investing
Active:
- Believes markets are inefficient;
- Active investing & market timing
Strategic Asset Allocation: ACTIVE strategy that assesses likely outcomes for various allocation mixes between classes; performed every few yrs
Tactical Asset Allocation: ACTIVE strategy that determines expected returns for asset classes then rebalances portfolio to take advantage; performed frequently
Passive:
- Believes markets are efficient
- Passive buy-and-hold strategy such as laddered bonds, ETf’s, or index investing
