Stock Valuation Questions and Answers

Stock Valuation Questions and Answers Common Stock Represents ownership in a publicly held company. Common Stock Claims & Liability Common stockholders have a residual claim on the firm's assets. Common stockholders have limited liability. Profit & Stock Value Higher profits increase a stock's value and lower profits decrease its value, in a direct relationship. Stocks & Interest Rates Higher interest rates decrease market value and lower yields and lower interest rates increase stock value, its a inverse relationship. Perpetuity A set payment amount that continues infinitely on regular intervals. Value of a Perpetuity = Annual Cash Flow / Discount Rate Stock Return = (Dividends + Change in Stock Price) / Beginning Stock Price Stock Value & Dividend Policy The dividend policy should not affect the current value of a stock. However, the expected future value of a stock is greatly affected by dividend policy. Technical Analysis Stock analysis based on the belief that prices are influenced more by investor psychology and the emotions of investors than by changes in the fundamentals of the company. Fundamental Analysis Stock analysis based on determining a stock's intrinsic value and the assumption that a company's stock price will move to its intrinsic value over time. Intrinsic Value The true value of a company's stock, which is a function of the company's revenue, growth, earnings, dividends, cash flows, profit margins, risk, interest rate, and any other factors that affect the value of a company. Target Stock Price Analysis Analysts forecast a firm's earnings per share and then multiply EPS by the firm's P/E ratio to determine the firm's target stock price. Relative Valuation Analysts compare a company's measure of value, including P/E ratio, price to book ratio, price to sales ratio, price to earnings to growth, to similar companies within the industry. Discounted Cash Flow Analysis A stock's value is determined by finding the sum of the company's expected future cash flows discounted back to today's dollars at an appropriate interest rate. Discounted Dividend Model The most basic DCF approach, where the value of a stock is the present value of the dividends that an investor expects to received from the stock if the investor holds the stock forever. Free Cash Flow to Equity Model Measures the company's cash flows after accounting for payments for working capital, capital expenditures, the interest and principal on debt, and dividends on preferred stock; then discounts those cash flows at the company's cost of equity to arrive at the stocks value. Free Cash Flow to the Firm Model A four step process to determine the value of the company's stock. FCF Model Steps 1. Forecast company's expected cash flows. FCFF = Revenues - Operating Expenses - Net Investment - Taxes 2. Estimate the company's weighted average cost of capital. 3. Calculate the enterprise value of the company. Enterprise Value = cash flow from operations + residual value + short-term assets 4. Calculate Intrinsic Stock Value Intrinsic Value = enterprise value - long term debt - short term liabilities - preferred stock Modern Portfolio Theory Based on belief that stock prices always reflect intrinsic value and that any type of fundamental or technical analysis is already embedded in the stocks price. Excess Return Period Period where the returns a company earns on a new investment is greater than the company's WACC Boring Companies 1-year excess return period: companies in highly competitive, low margin industries. Decent Companies 5-year excess return period: companies with decent reputations but that don't control pricing or growth in their industry. Good Companies 7-year excess return period: companies with good brand names and large economies of scale. Great Companies 10-year excess return period: companies with great growth potential, brand names, and marketing power.