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Investments CFP > Valuation of Stocks and Bonds > Flashcards

Valuation of Stocks and Bonds Flashcards

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1
Q

Required rate of return is directly related to what

A

level of anticipated risk

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2
Q

The higher the risks, the higher the what and the lower the what.

A

Higher the risks, higher the required rate of return and lower NPV

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3
Q

If a person pays too much for an investment, their returns will be higher or lower than the required/expected?

A

Returns will be lower than the required/expected if you pay too much

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4
Q

If your required IRR is 8% and an investment pays $100 a year - to get the required IRR what would you be willing to pay?

A

$100/.08 = $1,250

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5
Q

Why are stocks more difficult to value than bonds?

A

no maturity date, dividends are variable and uncertain

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6
Q

Some ways to value stocks

A

-capitalized earnings
-dividend growth model
-ratio analysis
-book value

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7
Q

Capitalized Earnings:
Stock has expected earnings of $1.05 and required rate of return (cap rate) of 8%. What is the intrinsic value of the stock?

A

1.05/.08 = $13.125

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8
Q

Capitalized Earnings Formula

A

Expected earnings/required rate of return (cap rate)

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9
Q

Dividend of $3.50 per year on a stock is expected to continue in perpetuity. If our required rate of return is 10% what is the value of the stock?

A

$3.50/.10 = $35

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10
Q

Dividend Growth Formula

A

D one/required rate of return - g

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11
Q

Stock has annual earnings of $3.50 that are expected to grow by 5% a year. Required rate of return is 10% = what is the value of the stock?

A

$3.50 * 1.05 / .10 = $73.50

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12
Q

Stock has annual earnings of $3.50, expected to grow at 5% a year, our required rate of return is 10% and you paid $50 for the stock what is your expected return?

A

$3.50 * 1.05 / 50 + 5% = 12.35%

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13
Q

If you pay less than intrinsic value, will your expected return be higher or lower?

A

higher

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14
Q

Dividend growth valuation model

A

V = dividend* growth rate / required rate- growth rate

D is dividend
r = required rate of return (from CAPM)
g = dividend growth rate

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15
Q

Expected rate of return

A

r = D * growth rate /Current price + g

g is dividend growth rate

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16
Q

Price to Earnings

A

price/earnings
$20.41/$2.875 = 7.14

Investor is paying 7.14 times earnings

OR $7.14 for every $1 of earnings

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17
Q

Some weaknesses to price to earnings

A
  • diff definition of earnings for diff co’s
  • diff in estimated earnings
  • question of appropriate multiple
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18
Q

Price to free cash flow

A

Price/free cash flow per share
$20.41/$1.04 = 19.62

Investor paying 19.62 times free cash flow

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19
Q

Companies stock is 20x free cash flow which is $1 per share what is fair value

A

20 * 1 = $20

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20
Q

Book value definition

A

assets - liabilities - preferred stock - intangible assets like goodwill

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21
Q

Book value per share is $2.25
P/B should be 8.0

What is the book value

A

8 * 2.25 = $18.00
value is 8 times book value

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22
Q

Price is $45.50
Earnings are $6.50
Growth is 10%
What is peg ratio

A

$45.50/6.50 = 7
7/10 = .7

.7 is PEG

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23
Q

When comparing 2 stocks, would you take the stock with a higher or lower PEG ratio?

A

lower

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24
Q

Top down analysis

A

Economy -> sectors -> Industry -> individual companies

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25
Q

Bottom up strategy

A

companies considered based on their own merit w/o regard for economic outlook
Look at: management, history, biz model, growth prospects etc

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26
Q

Ratio Analysis

A

used in fundamental analysis - calculation of financial ratios using info from balance sheet and income statement

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27
Q

Time series analyis

A

same firm or several firms over a period of time

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28
Q

Cross-sectional analysis

A

several firms in same industry at a given time

29
Q

Balance sheet includes

A

assets, liabilities, equity

30
Q

Income Statement includes

A

revenue, expenses

31
Q

Liquidity ratios measure what

A

firm’s capacity to meet its current obligations as they come due

32
Q

Quick ratio

A

Current assets - inventory/Current liabilities

33
Q

Why is inventory not included in quick ratio?

A

Because inventory might not be able to be quickly sold and thus can’t contribute to firm’s liquidity

34
Q

Activity ratio shows

A

how rapidly assets flow through the firm

35
Q

Rapid turnover of inventory does what

A

generates cash to meet current liabilities in a timely manner

36
Q

Receivables turnover formula

A

annual credit sales (or sale) / account receivable

37
Q

Inventory Turnover

A

sales/average inventory
OR
CGS/avg inventory

38
Q

Average collection period

A

receivables/sales per day

39
Q

Fixed asset turnover ratio

A

annual sales/fixed assets

long term fixed assets would include property, plant, and equipment

40
Q

4 activity ratios (turnover)

A

inventory turnover, receivables turnover, fixed asset turnover, average collection period

41
Q

Profitability ratios measure what

A

how profitably the firm is being run or how efficiently they are using assets

42
Q

Gross profit margin
(think g for cgs)

A

revenues - CGS / Sales

43
Q

Operating Profit Margin

A

Earnings before interest and taxes/sales

44
Q

Net profit margin

A

net income/sales

45
Q

Return of Assets

A

net income/total assets

46
Q

Return (what do you make) on Equity

A

net income/equity

47
Q

Return on Common

A

Equity net income - preferred stock dividends/Common equity

48
Q

ROE using DuPont System

A

net income/sales * sales/assets * assets/equity

49
Q

Operating profit margin measures what

A

EBIT/Sales
measures how much the firm earns on sales before considering how the firm is financed or how much it pays in taxes

50
Q

Measuring gross profit, operating profit, and net profit allows an analyst to do what

A

computing all 3 ratios lets the analyst determine if diff in net income are result of differences in cost of goods sold, operations, interest expense or taxes

51
Q

Debt ratios measure what

A

extent to which a firm uses financial leverage

52
Q

2 ways to measure debt

A

debt to assets or debt to equity

53
Q

Usage of debt is one of the sources of what type of risk

A

diversifiable unsystematic risk, i.e. financial risk

54
Q

Usage of debt might result in higher EPS but

A

does not mean a higher stock price because investors might be unsure if EPS would counteract the debt/risk

55
Q

Debt to Equity

A

debt/equity

56
Q

Debt to Total Assets

A

debt/total assets

57
Q

Coverage ratio (times interest earned)

A

earnings before interest and taxes / interest expense

58
Q

Times Interest Earned measures what

A

does EBIT outweigh interest expense - measures the safety of the interest payments

59
Q

Businesses make interest payments out of what

A

operating income

60
Q

What firms might use modest amounts of debt financing

A

firms with conservative management or firms that don’t need a ton of debt to grow

61
Q

What is a sign of successful use of leverage

A

larger return on its equity than assets

62
Q

Bank use of debt example

A
  • bank earns < 1% on assets
  • typical bank equity is 5-10% of its sources of funds
  • large amount of debt financing and small interest paid for obligations increases equity return to 12-15%
63
Q

How long would it take for a series EE bond to double?

A

20 years

64
Q

Series EE bonds are purchased at what value relative to face value?

A

1/2 face value

65
Q

Minimum/maximum purchase price on Series EE bond

A

$25 for $50 face value bond
$5000 for $10k face value bond

66
Q

Does a zero coupon bond have reinvestment risk?

A

No, they dont pay interest so theres no interest to reinvest

67
Q

Cumulative Preferred Stock

A

Must pay all unpaid dividends from prior year before paying dividend to common

68
Q

Do open ended mutual funds issue new shares or redeem existing shares from shareholders?

A

Yes

69
Q

Would a mutual fund company buy a GIC?

A

No a pension company would use a GIC

Investments CFP (14 decks)

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