Stock Valuation and Ratio Analysis _ Bonds _ Bond Valuation Flashcards
How do you use the constant growth dividend discount model to value a company’s stock?
by discounting the future stream of cash flows
formula used is known as the intrinsic value formula
** be sure to use next year’s dividend when determining the value of stock
How do you determine if a stock is over- or undervalued based on the intrinsic value formula?
Calculate the future value using the formula.
Compare the value to the current stock price.
What are the relationships between required rate of return, dividend growth, and stock price?
If the required ROR decreases, the stock price will increase.
If the dividend is expected to increase, the stock price will increase.
If the required rate of return increases, the stock price will decrease.
if the dividend is expected to decrease, the stock price will decrease.
What makes the Price-Earnings Ratio helpful?
P/E = Price Per Share / EPS
OR
Price Per Share = P/E X EPS
useful to value stock paying no dividends
What is the PEG Ratio?
Price/Earnings to Growth (PEG) ratio compares a stock’s 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 is the historical earnings growth rate
- PEG = 1 suggests stock is fairly valued because P/E ratio is in line w/ the earnings growth rate
- PEG > 1 suggests stock is fully valued (or even overvalued), an expanding P/E ratio is contributing to the stock price appreciating more than the earnings growth rate
What is the Dividend Payout Ratio?
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 / Earning Per Share
- typically the higher the ratio the more mature the company
- a high ratio may indicate possibility of the dividend being reduced
- low ratio may indicate dividend may increase and increasing the stock price
What is Return on Equity (ROE)?
measures the overall profitability of a company
direct relationship between ROE, earnings and dividend growth
ROE = EPS / Shareholders Equity per Share
What are the different tools of technicians for stock valuation?
Charting (50-, 100- , or 200-day moving average with historical stock prices)
Market Volume
- high volume, market down = negative indicator
- low volume, market up = negative indicator
- low volume, market down = positive indicator
- high volume, market up = positive indicator
Short Interest
- high short interest = “pent up” demand
Odd Lot Trading
The Dow Theory
Breadth of the Market
Advance Decline Line
What are the 3 forms of the Efficient Market Hypothesis?
- Weak Form
- historical info doesn’t help investors
- rejects technical analysis, fundamental analysis will help
- security prices reflect all price and volume data - Semi-Strong Form
- both historical and public info don’t help
- rejects both technical and fundamentals
- inside info will help - Strong Form
- historical, public and private info don’t help
- prices reflect all available info and react immediately to new info
- even with inside info the market cannot be out performed on a consistent basis
What are the Market Anomalies that are exceptions to the rule that markets are efficient?
January Effect - JAN better month due to NOV & DEC tax loss selling
Small Firm Effect - small caps tend to outperform large caps
Value Line Effect - stocks w/ highest ranking (1) outperform stocks that receive lowest ranking (5)
P/E Effect - stocks with a low P/E tend to outperform stocks with a high P/E
** Anomalies do not support EMH in any of the 3 forms (weak, semi-strong, strong)
What are Series EE/E Bonds?
Nonmarketable US Treasury Issues
Sold at face value - $25 minimum purchase ($10,000 annual max)
Offered at 1/2 face value
Do not pay interest periodically, slowly increases in value over 20 years, fixed rate
Redeemable after 1 year w/ 3M interest penalty if redeemed < 5 years
Interest not subject to income taxes until redeemed
May qualify for tax free treatment for education expenses
Interest not taxed at state or local level
What are Series I Bonds?
Inflation-indexed bonds issued by the US gov’t
Sold at face value, no guaranteed rate or return
Interest portion consists of two components:
1. Fixed rate of return
2. Inflation component adjusted every 6M
What are Marketable US Securities?
US T-Bills
- Maturities < 1Y
- Sold on discounted yield basis, do not pay interest, bonds just mature at par value
US T-Notes
- Maturities of 2-10Y
- Interest paid semi-annually
US T-Bonds
- Maturities > 10Y
- Interest paid semi-annually
All sold in denominations of $100 or more
All sold on an “auction” basis w/ lowest yield winning the auction
What is an Original Issue Discount (OID)?
Issued at a discount from par value
Example is a zero-coupon bond sold at a deep discount to par value
Zero-coupon bonds the bond holder must recognize income each year even though no interest received “phantom income”
How do Separate Trading of Registered Interest Principal Securities (STRIPS) work?
periodic coupon payments separated from the bond and each coupon payment, including the par value, trade separately
essentially treasury STRIPS create zero-coupon bonds
highly liquid and appropriate for investors looking for a low risk, highly liquid investment, and with a specific time horizon
What is the only federal agency security with a direct obligation of the gov’t and backed by the full faith and credit of the US gov’t?
Governmental National Mortgage Association (GNMAs), division of Dept of Housing and Urban Development
What are the Bond Rating Agencies investment quality bond ratings and junk bond ratings?
Investment Quality Bonds
- Moody’s = Aaa - Baa
- Standard & Poor’s = AAA - BBB
Junk Bonds
- Moody’s = Ba and below
- Standard & Poor’s = BB and below
What are the three types of Municipal Bonds?
- General Obligation Bonds = backed by the full faith, credit, and taxing authority of the issuing municipality
- Revenue Bonds = backed by the revenue of a specific project, NOT backed by the full faith, credit, and taxing authority of the issuing municipality
- Private Activity Bonds = used to finance construction of stadiums
What insurance companies insure municipal bonds?
American Municipal Bond Assurance Corp (AMBAC)
Municipal Bond Insurance Association Corp (MBIA)
If an insured muni bond is in default, the insurance company will pay the interest an principal amounts.
What are the Fixed Income Risks?
Corporate Bonds
- Default
- Reinvestment Rate
- Interest Rate
- Purchasing Power
US Gov’t Bonds
- Reinvestment Rate
- Interest Rate
- Purchasing Power
- Muni bonds have default risk unless they are insured.
What is double or triple-tax-free?
Combine the federal, state and local income tax rate and use for the marginal tax rate in they Tax-Equivalent Yield (TEY) formula.
TEY = r / (1-t)
r = tax exempt yield
t = marginal tax rate
Tax-Exempt Yield = Corporate Rate X (1 - Marginal Tax Rate)
double-tax-free = bond holder must live in the state issuing the muni bond
triple-tax-free = bond holder must live in the local municipality issuing the bond
How do you calculate the TEY for both Federal and State Taxes?
TEY = Tax Exempt Yield \ [1 - (Federal Tax Rate + State Tax Rate (1 - Federal Tax Rate))]
** Only use if individual itemizes deductions on their tax return. Otherwise, just add the federal and state tax rates and use the TEY formula.
What is the difference between Coupon Rate and Current Yield for bonds?
Coupon Rate = Coupon Payment / Par
Current Yield = Coupon Payment / Bond Price
How do you calculate the Bond HPR?
What do you use when calculating YTC for a bond?
Use the number of periods until the bond is called not the time until maturity.
** Multiply the selling price by the interest to get the PMT. Be sure to divide the PMT by 2 for the semiannual amount to be used in the calculation.
PV = selling price
N = callable time horizon X 2
FV = callable $ amount
Solve for I/YR.
What is the relationship between Coupon, Current Yield, YTM, and YTC?
What is the Yield Ladder?
Remember if you see a Discount “Call Mom’s Cell Now!”
Discounts (from highest to lowest) is yield to CALL, YTM, CY, Nominal Yield (Coupon Rate)
What are the important features about bond duration?
Duration is the weighted average maturity of all cash flows.
- bigger the duration, the more price sensitive or volatile to interest rate changes
- duration is the moment in time the investor is immunized form interest rate risk and reinvestment rate risk
- modified duration is a bond’s price sensitivity to interest rate changes
- bond portfolio should have a duration equal to the investor’s time horizon to be effectively immunized
What is relationship of coupon rates to duration?
A zero-coupon bond will always have a duration equal to its maturity.
As the coupon rate increases, the duration decreases.
As the coupon rate decreases, the duration increases.
As YTM increases, duration decreases. As YTM decreases, duration increases.
Term increases or decreases, duration will increase or decrease.
Inverse between CR/YTM and duration.
** Coupon and YTM are INterest rates and there is an INverse relationship.
How do you calculate bond duration using present value of cash flows?
** Keep P/YR = 1
** Period X Payment = FV
** PV = Period X PMT
** Sum PV / Bond Selling Price = Duration
USE THIS IN PLACE OF THE DURATION FORMULA
y = bond YTM
c = bond CR
t = number of periods to maturity
** adjust y,c, and t if compounding is semiannual; simply divide y and c by 2 and multiply t by 2
Estimating Bond Price (what is the formula and it’s variables)?
D = Duration
y = YTM
delta y = Change in interest rates
delta P / P = % price change
How do you calculate bond price when you have duration, change in interest rates, YTM, and selling price?
What is a primary built in benefit for convertible bonds?
Even if the stock does not perform well, the investor’s floor is the bond par value the investor will receive if the convertible is held to maturity.
Conversion Value (CV) = [PAR / CP] X Ps
PAR = par value
CP = conversion price
Ps = common stock price
1000 / CP = the conversion ratio or number of shares the convertible can be converted into
What is the Property Valuation formula?
Used to determine how much an investor is willing to pay for property
Capitalized Value = NOI / Cap Rate
Cap Rate = NOI / Cost
How do you calculate property value or capitalized value using the property valuation formula?
