Chapter 7: Valuing Stocks

Question 1

common stock; common equity; common shares

Answer 1

ownership shares in a corporation

Question 2

primary market

Answer 2

market for the sale of new securities issued by corporations

Question 3

initial public offering (IPO)

Answer 3

first offering of stock to the general public

Question 4

seasoned equity offering (SEO)

Answer 4

sale of additional stock by a public company

Question 5

secondary market

Answer 5

market in which already-issued securities are traded among investors

Question 6

price-earnings multiple (or P/E ratio)

Answer 6

ratio of stock price to earnings per share

Question 7

dividend yield

Answer 7

a stock’s cash dividend by its current price

Question 8

preferred stock

Answer 8

stock that takes priority over common stock in regards to dividends

Question 9

book value of equity

Answer 9

net worth of the firm according to the balance sheet

Question 10

liquidation value

Answer 10

net proceeds that would be realized by selling the firm’s assets and paying off its creditors

Question 11

market-value balance sheet

Answer 11

financial statement that uses the market value of all assets and liabilities

Question 12

intrinsic value

Answer 12

present value of expected future cash flows from a stock or other security

Question 13

dividend discount model

Answer 13

discounted cash flow model that states that today’s stock price equals the present value of all expected future dividends

Question 14

constant-growth dividend discount model

Answer 14

version of the dividend discount model in which dividends grow at a constant rate

Question 15

payout ratio

Answer 15

fraction of earnings paid out as dividends

Question 16

plowback ratio

Answer 16

fraction of earnings retained by the firm (also called retention ratio)

Question 17

sustainable growth rate

Answer 17

steady rate at which a firm can grow; return on equity x plowback ratio

Question 18

present value of growth opportunities (PVGO)

Answer 18

net present value of a firm’s future investments

Question 19

technical analysts

Answer 19

investors who attempt to identify undervalued stocks by searching for patterns in past stock prices

Question 20

random walk

Answer 20

the movement of security prices that change randomly, with no predictable trends or patterns

Question 21

fundamental analysts

Answer 21

investors who attempt to find mispriced securities by analyzing fundamental information, such as accounting data and business prospects

Question 22

inside information

Answer 22

relevant information about a company known by its board of directors, management and/or employees, and other insiders but not by the public

Question 23

insider

Answer 23

member of the board of directors, management, employees, and others with a close relationship to a company, including lawyers, financial advisors, and accountants

Question 24

insider trading

Answer 24

illegal trading of securities, including stocks, bonds and options, by insiders or those tipped by insiders, on the basis of inside information

Question 25

efficient market

Answer 25

market in which prices reflect all available information

Question 26

weak-form efficiency

Answer 26

market prices rapidly reflect all information contained in the history of past prices

Question 27

semi-stong-form efficiency

Answer 27

market prices rapidly reflect all publicly available information

Question 28

strong-form efficiency

Answer 28

market prices rapidly reflect all information that could in principle be used to determine true value