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2nd Year - Finance 1 > Lecture 6 - Valuing Shares > Flashcards

Lecture 6 - Valuing Shares Flashcards

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1
Q

What is valuation by comparables?

A

Seeing how much investors in a sample of similar firms are prepared to pay for each dollar of assets or earnings.

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2
Q

How can you value common stocks?

A

Market-to-book and price-to-earnings ratios or other multiples such price-to-sales ratio, for firms who do not have earnings (infant firms).

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3
Q

What is the value of a bond?

A

The present value of its coupon payments plus the present value of its final payment of face value.

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4
Q

Compare stocks and bonds.

A

Instead of receiving coupon payments as you do with bonds, with stocks investors may receive dividends. Instead of receiving the bond’s face value, with stocks investors will receive the stock price at the time they sell their shares.

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5
Q

Riskier firms will have…

A

Higher discount rates.

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6
Q

What is the intrinsic value?

A

The present value of future cash payoffs from a stock or other security.

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7
Q

What does the discount rate reflect?

A

The risk of the stock.

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8
Q

What is expected return?

A

The percentage yield that an investor forecasts from a specific investment over a set period of time. Sometimes called the holding period return.

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9
Q

What is the aim of an investor?

A

To buy shares at a price that is less than intrinsic value.

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10
Q

What happens in competitive markets?

A

Only the intrinsic value survives.

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11
Q

What happens in a well functioning market?

A

All equally risky securities are priced to offer the same expected rate of return.

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12
Q

What is the dividend discount model?

A

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

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13
Q

What is the final horizon date for stocks?

A

It is not specified. Stocks do not “mature”.

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14
Q

What is the stock price at the horizon date determined by?

A

The expectations of dividends from that date forward.

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15
Q

Why does a company that pays out all its earnings to its common shareholders not grow?

A

It does not reinvest. Its shareholders might enjoy generous immediate dividends, but they could not look forward to higher future dividends.

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16
Q

What is the constant growth dividend discount model?

A

Version of the dividend discount model in which expected dividends grow at a constant rate.

17
Q

What is a sustainable growth rate?

A

The firm’s growth rate if it plows back a constant fraction of earnings, maintains a constant return on equity , and keeps its debt ratio constant.

18
Q

What is payout ratio?

A

Fraction of earnings paid out as dividends.

19
Q

What is plowback ratio?

A

Fraction of earnings retained by the firm.

20
Q

What is the present value of growth opportunities (PVGO)?

A

The net present value of a firm’s future investments.

21
Q

What is a true ‘growth stock’?

A

One where the net present value of its future investments accounts for significant fraction of the stock’s price.

22
Q

What will the P/E be of a firm that earns nothing?

A

They will have infinite P/E.

23
Q

What does a high P/E suggest?

A

Investors think that the firm has good growth opportunities.

24
Q

What is the purpose of discounted cash flow?

A

To estimate market value - to estimate what investors would pay for a stock or business.

25
Q

It does not matter whether you forecast dividends per share or the total free cash flow of a business. Value today always equals…

A

Future cash flow discounted at the opportunity cost of capital.

26
Q

What is free cash flow?

A

Cash flow available for distribution to investors after firm pays for new investments or additions to working capital.

27
Q

Can free cash flow be zero or negative for rapidly growing businesses?

A

Yes. Free cash flow may be zero because a firm is rapidly growing not because it is unprofitable.

28
Q

What does the growth rate determine?

A

The net additional investment required.

29
Q

What does the return on equity determine?

A

Net income as a percentage shareholder’s equity.

30
Q

Dividends are not the only way that firms can return cash to their equity investors. What happens in a repurchase?

A

In a repurchase, the firms buys back a small fraction of the outstanding shares of its shareholders.

31
Q

What are value stocks?

A

Those with a high ratio of book to market value.

32
Q

What are growth stocks?

A

Those with low ratios of book to market.

2nd Year - Finance 1 (10 decks)

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