# Investments: Stock Valuation And Ratio Analysis Flashcards

1

Q

Dividend Discount model

A

- provides intrinsic value of a stock by discounting the future stream of cash flows
- also known as the Gordon growth model and intrinsic value formula

2

Q

Expected rate of return

A

Calculate an expected rate of return (r)

- this formula uses market price (P), in place of value (V)
- provided on exam don’t memorize

3

Q

Exam Tip: Dividend Discount model

A

- if the required rate of return 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

4

Q

Dividend discount model example

A

5

Q

Disadvantages - Dividend Growth Rate model

A

- the model requires a constant, perpetual growth rate of dividends
- many stocks 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 becomes very sensitive to expected return when nearing the growth rate.

6

Q

Dividend discount model - Variable Dividend Growth rates

A

7

Q

Price-Earnings (P/E) Ratio

A

- represents he much an investor is willing to pay for each dollar if earning.
- measure of relationship between a stocks price and its earnings.
- useful tool used to value a stock if the firm pays no dividends.

8

Q

The Price/earnings Growth (PEG) Ratio

A

- Compares a stocks P/E ratio to the company’s 3 to 5 year growth rate in earnings (historical growth rate)
- used to determine if the stocks P/E ratio is keeping pace with the firms growth rate in earnings.
- PEG ratio = 1 - means the stock is fairly valued because P/E ratio is in line with earnings growth rate.
- PEG ratio > 1 - suggest stock is fully or overvalued because an expanding P/E ratio is contributing to the stock price appreciating more than growth rate of earnings.

9

Q

What is book value?

A

- book value represents the amount of stockholders equity in the firm or how much the company’s shareholders would receive if firm was liquidated.
- useful to compare to stocks price.
- stock price > book value - firm is overvalued
- stock price =or< book value - firm is undervalued.

10

Q

Dividend payout ratio

A

- formula not on exam sheet
- relationship between amount of earnings paid to shareholders in the firm of a dividend, relative to earnings per share.
- higher the dividend payout ratio = company more mature, possibility of dividend being reduced
- low dividend payout ratio = dividend may increase therefore increasing stock price

11

Q

Dividend payout ratio - example

A

12

Q

Return on Equity (ROE)

A

- measures overall profitability of the company.
- not in CFP formula sheet MEMORIZE
- direct relationship between ROE, earnings and dividend growth

13

Q

Return on equity example

A

14

Q

Dividend Yield Formula

A

-states the annual dividend as a percentage of stock price

15

Q

Dividend Yield example

A

16

Q

Dollar cost averaging

A

The investor buys fewer shares when the price increases and more shares when the price decreases.