Stock Valuation and Ratio Analysis Flashcards
what is the constant growth dividend discount model?
values a company’s stock by discounting the future stream of cash flows
what are some disadvantages to the dividend discount model?
- model requires a constant, perpetual growth rate of dividends
- many stocks do not pay dividends
- growth rate of dividends cannot be greater than the expected return and the security price becomes very sensitive to the expected return when nearing the growth rate
describe the Price to Earnings ratio
represents how much an investor is willing to pay for each dollar of earnings
a measure of the relationship between a stock’s price and its earnings
what is the PEG ratio?
the price/earnings to growth ratio compares a stock’s P/E ratio to the company’s 3-to-5 year growth rate in earnings
what does a PEG ratio of 1 indicate?
the stock is fairly valued because the P/E ratio is in line with the earnings growth rate
what does a PEG ratio of greater than 1 indicate?
the stock price is fully valued (or even overvalued)
what is book value?
a firm’s book value represents the amount of stockholder’s equity in the firm or how much the company’s shareholders would receive if the firm was liquidated
describe the dividend payout ratio
the relationship between the amount of earnings paid to shareholders in the form of a dividend relative to the earnings per share
what does ROE (return on equity) measure?
measures the overall profitability of a company
what is dollar cost averaging?
allows an investor to invest the same dollar amount on a periodic basis
by investing the same dollar amount each month, an investor buys fewer shares when the price increases and more shares when the price decreases
what is fundamental analysis?
the process of conducting ratio analysis on the balance sheet and income statement to determine future financial performance and a forecasted stock price based upon that future financial perfomrance
what does fundamental analysis assume?
- investors can determine reliable estimates of a stock’s future price behavior
- some securities may be mis-priced
what is technical analysis?
the process of charting and plotting a stock’s trading volume and price movements, which will predict the future direction of stock prices long before fundamental analysis will
what are some of the tools used in technical analysis?
- charting
- market volume
- short interest
- odd lot trading
- The Dow Theory
- Breadth of the Market
- Advance Decline Line
what is the efficient market hypothesis?
- investors cannot consistently achieve above-average market returns
- prices reflect all information that is available and prices change very quickly to new information
- stock prices will follow a random walk
what is the Random Walk Theory?
the behavior of stock prices closely resembles a random walk
it’s impossible to consistently achieve above-average market returns
list the 3 forms of the efficient market hypothesis
- weak form
- semi-strong form
- strong form
what is the weak form of the efficient market hypothesis?
- historical information will not help investors achieve above-average market returns
- rejects technical analysis, asserts fundamental analysis will help
- security prices reflect all info and volume data
what is the semi-strong form of the efficient market hypothesis?
- both historical and public information will not help investors achieve above-average market returns
- rejects both technical and fundamental analysis
what is the strong form of the efficient market hypothesis?
-historical, public, and private information will not help investors achieve above-average market returns
which form of the efficient market hypothesis supports technical analysis?
none
if an investor is a proponent of index funds, which form of the efficient market hypothesis is the investor advocating?
strong (passive investment strategy)
what are some examples of market anomalies?
- January Effect
- small firm effect
- value line effect
- P/E effect
what is an active investment strategy?
investors believe the markets are inefficient, and that they can achieve above-average market returns through active investing and market timing
what is a passive investment strategy?
investors believe the markets are efficient, and a buy-and-hold strategy is best
what is strategic asset allocation?
a strategy that involves assessing the likely outcomes for various allocation mixes between asset classes
done every few years
what is tactical asset allocation?
the investor determines expected returns for asset classes, then rebalances the portfolio to take advantage of the expected returns
performed frequently
