IP - Chapter 11 - Equity Securities Valuation*

Question 1

Price an investor believes a stock is worth based on fundamental analysis

Answer 1

Intrinsic Value

Question 2

Two broad types of common stock valuation models for going concerns are?

Answer 2

1) Absolute Value

2) Relative Value

Question 3

A business that is expected to continue operations indefinitely

Answer 3

Going concern

Question 4

What is ‘absolute value’ common stock valuation?

Answer 4

Identifies a stock by its intrinsic value (based on PV of future cashflows)

Question 5

What is ‘relative value’ common stock valuation?

Answer 5

Compares the firms stock price to other similar companies

Question 6

What is an example of absolute value common stock valuation?

Answer 6

Dividend Discount Model

Question 7

What is an example of relative value common stock valuation?

Answer 7

PE Ratio

Question 8

An absolute valuation of common stock technique that attempts to point estimate of future cash flows discounted at an appropriate discount rate today?

Answer 8

Present Value Model

Question 9

Limited operational business life (ie. typewriter company)

Answer 9

Not a going concern

Question 10

How are companies that are not a going concern valued?

Answer 10

FMV of companies assets minus FMV of companies liabilities

Question 11

What is the Basic Present Value Model formula that calculates the value of a security today?

Answer 11

CF1 / ((1 + Discount Rate) ^ Year)

Question 12

What model allows for growth rates to change over time?

Answer 12

Two Stage Dividend Growth Model

Question 13

Companies in the S&P 500 that have increased their dividends consistently over the last 25 years.

Answer 13

Dividend Aristocrats

Question 14

V = D1 / (r - g)

Answer 14

Constant growth dividend model (ON CFP FORMULAS SHEET)*

V = Value of Stock
D1 = Dividend per share (also computed as D1(1+g))
r = required return of investor
g = dividend growth rate

Question 15

r = (D1/P) +g

Answer 15

Constant Growth Dividend Model when given a price

Question 16

In theory, a firms operating cashflow can only grow if:

Answer 16

1) Operating Cashflows increase

2) External Financing

Question 17

Measure of cashflow to be paid to shareholders

Answer 17

FCFE (Free Cashflow to Equity)

Question 18

Means identical assets should sell for identical prices

Answer 18

Law of 1 Price

Question 19

What are 4 common relative valuation methods?

Answer 19

PE Ratio, Price to Book, Price to Sales, PEG Ratio

Question 20

What are ratios like PE and P to B also referred to as?

Answer 20

Multiples

Question 21

Amount of money investors are willing to pay for a single dollar worth of earnings

Answer 21

PE Ratio

Question 22

What is another formula for PE Ratio?

Answer 22

(D1 / E) / (r - g)

Question 23

This ratio is a measure of PE Ratio per unit of EPS Growth

Answer 23

PEG Ratio:

PE Ratio / EPS Growth

Question 24

(Total Market Value Price X Shares Outstanding) / (Sales)

Answer 24

Price to Sales Ratio

Question 25

Undervalued firms typically have low ___________ ratios?

Answer 25

Price to Book

Question 26

This model estimates cash flows the security is likely to pay and them discounts them at the appropriate interest rate to find value?

Answer 26

Basic Present Value Model

Question 27

This model computes value as the present value of an infinite growing dividend stream?

Answer 27

Dividend Discount Model

Question 28

This model helps to estimate a firms intrinsic value per share?

Answer 28

Constant Growth Dividend Model

Question 29

How can a firms dividend growth rate be estimated ? (2 ways)

Answer 29

1) Retention Ratio | 2) Firms Return on Equity

Question 30

How is preferred stock valued?

Answer 30

Using the zero growth rate assumption in the dividend discount model (ie. V = D1(1+g) / (r - g)... setting g = 0 makes V = D1/r)

Question 31

This model assumes that a firms dividends grow at DRAMATICALLY/EXTREMELY different rates during a high growth period that is followed by an infinite normal growth period.

Answer 31

Two stage dividend discount model

Question 32

The expected future selling price in the two stage dividend discount model?

Answer 32

Terminal Price

Question 33

Dividend discount model in which dividends change GRADUALLY from a high growth rate to a low normal growth over a period of years.

Answer 33

H Model

Question 34

For firms that either do not pay dividends or for firms that pay dividends that are substantially different than its earnings, __________ can be used as an input variable in a present value model to estimate intrinsic value.

Answer 34

Free Cash Flow

Question 35

Cash available to common share holders after the firms bond-holders and preferred share holders have been paid?

Answer 35

Free Cash Flow to Equity

Question 36

The most commonly used relative valuation measure?

Answer 36

Price to Earnings Ratio

Question 37

Lower ratios of this imply undervaluation?

Answer 37

PEG Ratio

Question 38

How do you calculate PEG Ratio?

Answer 38

PE Ratio/EPS Growth Rate

Question 39

Ratio of a firms stock price to its revenues per share

Answer 39

Price to sales ratio

Question 40

Ratio of a firms stock price to its cashflow per share

Answer 40

Price to cash flow ratio

Question 41

PE Ratio based on expected 12 months of earnings

Answer 41

Leading PE Ratio

Question 42

PE Ratio based on trailing 12 months of earnings or the most recent four quarters.

Answer 42

Trailing PE Ratio

Question 43

These values can be estimated using the present value approach even though they have different types of cashflows?

Answer 43

Both Stock Values and Bond Values

Question 44

If the market price of a firms stock is less than its intrinsic value the stock is most likely to be _______________ .

Answer 44

Undervalued

Question 45

This approach is appropriate for natural resource firms.

Answer 45

FMV approach

Question 46

When utilizing the constant dividend growth model you must first solve for what?

Answer 46

Growth rate (ie. Interest rate) using financial calculator

Question 47

BE SURE TO KNOW CFP GIVEN FORMULA SHEET!

Question 48

How to calculate required rate of return if it is not given in a problem?

Answer 48

Use CAPM Formula to solve --> RFR + Beta(Market Return - RFR)