Stock Valuation and Ratio Analysis (L4) Flashcards
1
Q
Dividend Discount Model
A
(Provided formula)
- The constant growth dividend discount model values a company’s stock by discounting the future stream of CFs
- The formula is known as the Gordan Growth Model, and INTRINSIC VALUE Formula:
- Dividend Discount Model may be utilized for simplistic perpetual dividend growth rate questions OR for more complicated variable dividend growth rates (pg. 69)
- D1 is next expected dividend. It is calculated using the current divident and dividend growth rate…
○ D1 = D0 (1+g)
2
Q
Disadvantages of the DDM
A
- The model requires a constant, perpetual growth rate of dividends
- Many stock 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 return and the security price becomes very sensitive to the expected return when nearing the growth rate
3
Q
Expected Rate of Return
A
(Provided formula)
- R = (D1 / P) + g
- Through a restructuring of the formula used to calculate value, you can calculate the Expected Rate or Return (r)
- The formula uses “price” (P), that is, market price, in place of value (V) in the calculation
- If a Required RoR INCREASES ==> Stock Price will INCREASE
- If a Required RoR DECREASES ==> Stock Price will DECREASES
- If Dividend is expected to INCREASE ==> Stock Price will DECREASE
- If Dividend is expected DECREASE==> Stock Price will INCREASE
4
Q
Earnings Per Share (EPS)
A
Price per Share = P/E * EPS
5
Q
Price Earnings (PE) Ratio
A
Price per Share = P/E * EPS
- Represents how much an investor is willing to pay for each dollar of earnings
○ It is a measure of the relationship between stock’s
price and its earnings - USEFUL took used to value a stock if the firm pays NO DIVIDEND.
○ The relationship of price to earnings is known as
the PE MULTIPLIER.
6
Q
PEG Ratio
A
- The Price/Earnings to Growth (PEG) ratio compares a stock PE ratio the company’s 3-to-5-year growth rate in earnings (Expected EPS Growth)
- The PEG Ratio is used to determine if the stock’s PE Ratio is keeping pace with the firm’s growth rate in earnings
- The PEG Ratio = 1
○ Suggests that the stock is fairly valued because the
PE ratio is in line with the earnings growth rate - PEG Ratio > 1
○ Suggests that the stock price is fully valued (or
even undervalued) because an expanding PE ratio is
contributing to the stock price appreciating more
than the growth rate of earnings
7
Q
Book Value
A
- A Firms 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
- The Book Value per Share is useful to compare to the firm’s stock price
- If the stock price is Significantly HIGHER than the firms book value
○ It may indicate that the firm is OVERVALUED - If the book value per share if EQUAL or HIGHER than the stock price
○ It may indicate that the firm is UNDERVALUED
8
Q
Dividend Payout Ratio
A
- The relationship between the amount of earnings paid to shareholders in the form of a dividend, relative to EPS.
- Typically, the higher the dividend payout ratio, the MORE MATURE the company
- A HIGH payout ratio
○ Indicate the possibility of the dividend being
REDUCED - A LOW payout ratio
○ Indicate that the dividend may INCREASE (thereby
increasing the stock price)
9
Q
Return on Equity (ROE) Ratio
A
- Measures the overall PROFITABILITY of a company (pg. 72)
- There is direct relationship between ROE, earnings and dividend growth
- ROE = EPS / Stockholders EPS
○ Stockholders EPS = Total Equity / Outstanding Shares
10
Q
Dividend Yield Formula
A
Formula states that ANNUAL dividend as a % of the stock price (pg. 73)
11
Q
Strategies to REDUCE Investors Risk
A
Dollar Cost Averaging
○ Allows an investor to invest the same dollar amount on a periodic basis (typically monthly)
○ By investing the SAME DOLLAR AMOUNT each month, the investor buy FEWER shares when the price INCREASES and MORE shares when the price DECREASES
○ Average price per share = Total Cost / # of shares
12
Q
Fundamental Analysis
A
- The process of conducting ratio analysis on the balance sheet and income statements to determine future financial performance and a forecasted stock price based upon that future financial performance
○ Includes a look at economic data to determine
how the economy will impact various industries
○ Economic Data:
§ Inflation
§ Interest Rates
§ GDP
§ Unemployment - Ratio Analysis INCLUDES:
○ Liquidity
○ Activity
○ Profitability
○ Common stock measurements - Fundamental Analysts believe that stock price performance is largely driven by the financial performance of the firm
- Fundamental Analysis ASSUMPTIONS:
○ Investors can determine reliable estimates of a
stock’s future price behavior
○ Some securities may be mispriced, and through
fundamental analysis, it can be determined which
securities are mispriced
13
Q
Technical Analysis
A
- The process of charting and plotting a stock’s trading volume and price movements
○ Analysis will predict the future direction of stock
prices long before fundamental analysis will. - DOES NOT involve ratio analysis OR analysis of financial statements (as fundamental analysis does)
- Technical analysts, who conducted technical analysis, believe supply and demand drive a stock price
- RESISTANCE may develop when investors who bought on an earlier high may now view this as a chance to get even
○ Some may see this as an opportunity to take a
profit - SUPPORT may develop when a stock does DOWN to a lower level of trading because investors may choose to act on a PURCHASE OPPORTUNITY that they previously passed.
○ This is a signal that new demand is coming into the
market.
14
Q
Tools of Technical Analysis
A
- Charting
- Market Volume
- Short Interest
- Odd Lot Trading
- The Dow Theory
- Breadth of the Market
- Advance Decline Line
15
Q
Charting
A
○ Involves plotting of historical stock prices to determine a trading pattern
○ Also involves a 50-, 100-, 200-day moving average along with historical stock prices
