Valuation of Stocks and Bonds Flashcards
Required rate of return is directly related to what
level of anticipated risk
The higher the risks, the higher the what and the lower the what.
Higher the risks, higher the required rate of return and lower NPV
If a person pays too much for an investment, their returns will be higher or lower than the required/expected?
Returns will be lower than the required/expected if you pay too much
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?
$100/.08 = $1,250
Why are stocks more difficult to value than bonds?
no maturity date, dividends are variable and uncertain
Some ways to value stocks
-capitalized earnings
-dividend growth model
-ratio analysis
-book value
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?
1.05/.08 = $13.125
Capitalized Earnings Formula
Expected earnings/required rate of return (cap rate)
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?
$3.50/.10 = $35
Dividend Growth Formula
D one/required rate of return - g
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?
$3.50 * 1.05 / .10 = $73.50
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?
$3.50 * 1.05 / 50 + 5% = 12.35%
If you pay less than intrinsic value, will your expected return be higher or lower?
higher
Dividend growth valuation model
V = dividend* growth rate / required rate- growth rate
D is dividend
r = required rate of return (from CAPM)
g = dividend growth rate
Expected rate of return
r = D * growth rate /Current price + g
g is dividend growth rate
Price to Earnings
price/earnings
$20.41/$2.875 = 7.14
Investor is paying 7.14 times earnings
OR $7.14 for every $1 of earnings
Some weaknesses to price to earnings
- diff definition of earnings for diff co’s
- diff in estimated earnings
- question of appropriate multiple
Price to free cash flow
Price/free cash flow per share
$20.41/$1.04 = 19.62
Investor paying 19.62 times free cash flow
Companies stock is 20x free cash flow which is $1 per share what is fair value
20 * 1 = $20
Book value definition
assets - liabilities - preferred stock - intangible assets like goodwill
Book value per share is $2.25
P/B should be 8.0
What is the book value
8 * 2.25 = $18.00
value is 8 times book value
Price is $45.50
Earnings are $6.50
Growth is 10%
What is peg ratio
$45.50/6.50 = 7
7/10 = .7
.7 is PEG
When comparing 2 stocks, would you take the stock with a higher or lower PEG ratio?
lower
Top down analysis
Economy -> sectors -> Industry -> individual companies
