Intrinsic Valuation Flashcards
What is the key aspect of stock valuation?
The key aspect of stock valuation is determining the intrinsic value of a company by estimating future cash flows and discounting them to present value.
What is the payout ratio in the context of dividends?
The payout ratio indicates the percentage of profits a company pays out as dividends to its shareholders.
How does a high payout ratio affect a company’s growth potential?
A high payout ratio might indicate that the company is distributing a significant portion of its earnings, leaving less room for future growth or investment.
What does a low payout ratio suggest about a company’s investment potential?
A low payout ratio suggests that the company is retaining more profits for reinvestment.
How do dividends indicate a company’s stability?
A stable and consistently increasing dividend history indicates a financially strong company with reliable earnings. Conversely, erratic dividend payments might raise questions about the company’s financial stability and management decisions.
How should dividends be considered when valuing a stock?
Dividends are just one component of the cash flows that determine the intrinsic value of a stock. Understanding dividends as indicators of stability and sustainability is key.
What is the concept of Discounted Cash Flows (DCF)?
DCF is a valuation method that involves estimating the present value of future cash flows. It accounts for the time value of money, recognizing that the value of money changes over time due to factors like inflation, opportunity costs, and uncertainty.
How does inflation impact the discount rate in DCF?
Inflation reduces the purchasing power of money over time. A higher expected inflation rate necessitates a higher discount rate, as future dollars will be worth less.
What are opportunity costs in the context of stock valuation?
Opportunity costs refer to the benefits given up when choosing one investment over another. In stock valuation, opportunity costs relate to the expected return on a risk-free investment. This influences the discount rate: a higher risk-free return would lead to a higher discount rate.
How does uncertainty affect the discount rate?
Uncertainty plays a significant role in stock valuation. Uncertain cash flow projections, especially for startups, result in higher discount rates, reflecting the higher risk. For established companies with stable earnings, the uncertainty is lower, leading to a lower discount rate.
What is the typical discount rate range for large-cap stocks?
For listed stocks with substantial market capitalization (few billion in market cap), a discount rate between 8% to 17% is typically used. This range considers inflation, opportunity costs, and uncertainty.
How is calculating the discount rate described as both an art and a science?
Calculating the discount rate involves both art and science. It requires assessing the impact of different factors, such as interest rate changes, timeframes, and assumptions.
What is Net Present Value (NPV) in the context of stock investing?
NPV is a tool used to determine the intrinsic value of investments by considering the time value of money and discounting future cash flows.
What is the discount rate?
The return I can expect to get at the market price the stock is currently trading for
What is the Internal Rate of Return (IRR) in the context of stock investing?
The IRR is a key metric for estimating the expected return on an investment. It solves for the discount rate instead of arbitrarily selecting one.
