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Investment Planning > Stock Valuation and Ratio Analysis > Flashcards

Stock Valuation and Ratio Analysis Flashcards

1
Q

What is the Dividend Discount Model?

A
  • AKA: contstant growth dividend discount model and intrinsic value model
  • Values a company’s stock by discounting future stream of cash flows
  • Formula:
    • V = D1 / (r - g)
      • r = required rate of return
      • g = dividend growth rate
      • D1 = Next period’s dividend (be sure to use NEXT years)
        • D1 = D0(1 + g)
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2
Q

What are the disadvantages to the dividend discount model?

A
  • Requires a constant, perpetual growth of dividends
  • Many stocks do not pay dividends so the security value may not be estimated with this model
  • The growth rate of dividends cannot be greater than the expected retun and the security price becomes very sensitive to the expected return when nearing the growth rate
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3
Q

What is the Price-Earnings Ratio?

A
  • Measures the relationship between a stock’s price and its earnings
    • How much an investor is willing to pay for each dollar of earnings
    • useful if stock pays no dividends
  • P/E = Price per Share / EPS
    • OR
  • Price per Share = P/E X EPS
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4
Q

What is the Price/Earnings to Growth (PEG) Ratio?

A
  • Compares stocks P/E ratio to the company’s 3-to-5 year growth rate in earnings
    • PEG Ratio = Stocks P/E ratio / 3-to-5 Year Growth Rate in Earnings
    • 3-to-5 Year Growth Rate in Earnings is the historical earnings growth rate
    • PEG = 1 = fairly valued
    • PEG > 1 suggest stock is fully/over valued because an expanding P/E ratio is contributing to the stock price appreciating more than the growth rate of earnings
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5
Q

What is Book Value?

A
  • The amount of stockholder’s equity in the firm or how much the company’s shareholders would receive if the firm was liquidated
    • Useful to compare to the firm’s stock price
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6
Q

What is the Dividend Payout Ratio?

A
  • The relationship between the amount of earnings paid to shareholders in the form of a dividend, relative to earnings per share
    • Dividend Payout Ratio = Common Stock Dividend / Earnings per Share
    • Typically, higher payout ratio, the more mature the company
    • A high DPR may indicate the possibility of the dividend being reduced
    • A low DPR may indicate the dividend may increase, thereby increasing the stock price
    • EXAM TIP: memorize, not on formula sheet
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7
Q

What is Return on Equity (ROE)?

A
  • measures overall profitability of a company
    • there is a direct relationship between ROE, earnings and dividend growth
    • ROE = EPS / Stockholders Equity per Share
    • EXAM TIP: memorize, not on formula sheet
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8
Q

What is the Dividend Yield Formula?

A
  • states the annual dividend as a percentage of the stock price
  • Dividend Yield = Dividend / Stock Price
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9
Q

What is the difference between Fundamental and Technical Analysis?

A
  • Fundamental
    • Financial Statement analysis and fundamental data
    • Assumes investors can determine reliable estimates of a stock’s future price behavior
    • FA can determine which securities are mispriced
  • Technical
    • Process of charting and plotting a stock’s trading volume and price movements, analysis will predict future diretion of stock prices long before FA will according to analysts
    • TAs believe supply and demand drive a stock price
      • Charting
      • Market Volume
      • Short Interest
      • Odd Lot Trading
      • The Dow Theory
      • Breadth of Market
      • Advance Decline Line
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10
Q

What is the Efficient Market Hypothesis (EMH)?

A
  • Investors cannot consistently achieve above-average market returns
  • Prices reflect all information that is available and change very quickly to new information
  • Stock prices follow a “random walk”
  • Investors believe a passive investment strategy is appropriate, e.g. a buy/hold index
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11
Q

What is the Random Walk Theory?

A
  • Behavior of stock prices resemble a random walk
  • Prices of stocks re unpredictable but not arbitrary
  • It is impossible to consistently achieve above-average market returns
  • At any given moment, prices reflect all available information and are a true reflection of the value of that security
  • Prices are in equilibrium
  • Changes in price and volume of trading are generated by changing needs of investors.
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12
Q

Describe the three basics of the Efficient Market Hypothesis:

A

ALL THREE REJECT TECHNICAL ANALYSIS

EMH Price Reflects Advantage through:

Weak Historical Price Data Fundamental Analysis & Inside Info

Semi-strong Public Information Inside Information

Strong All Information None

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13
Q

Describe the Weak Form of EMH:

A
  • Historical info WILL NOT help investors beat market
  • rejects technical analysis, asserts fundamental analysis will help beat the market
  • Holds that security prices reflect all price and volume data
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14
Q

Describe the Semi-Strong Form of EMH:

A
  • Both historical and public info WILL NOT help investors beat the market
  • rejects BOTH fundamental and technical analysis
  • Inside information will beat the market
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15
Q

Describe the Strong Form of EMH:

A
  • Historical, public and private info WILL NOT help investors beat the market
  • Suggests stock prices reflect all available info and react immediately to any new info
  • no way to gain advantage
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16
Q

A1: What are market anomalies?

A2: What are some examples?

A
  • A1: Exceptions to the rule that markets are truly efficient
  • A2:
    • January Effect
      • investors get back into stocks after Nov/Dec tax loss sales
    • Small Firm Effect
      • Easier for small companies to grow revenue and earnings
    • Value Line Effect
      • Highest ranking (1) outperform the lowest (5)
    • P/E Effect
      • low p/e stocks outperform high P/E stocks
17
Q

What are the differences between Active and Passive Investing Strategies?

A
  • Active
    • Investors believe markets are inefficient
    • Investors can beat market
  • Passive
    • Investors believe markets are efficient, can’t beat market
    • buy-hold
    • can be laddered bonds, ETFs, barbell bond, UITs, index investing
18
Q

What is Strategic Investing?

A
  • Involves assessing the likely outcomes for various alloction mixes between asset classes
  • Done every few years
  • Active strategy
19
Q

What is Tactical Investing?

A
  • Investor determines expected returns for asset classes, then rebalances portfolio to take advantage of expected returns
  • an active strategy
  • performed frequently

Investment Planning (8 decks)

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