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STOCK VALUATION AND RISK

STOCK VALUATION AND RISK. CHAPTER 11. STOCK VALUATION MODELS. The Importance of Efficient Stock Valuation Models Identify over- or under-valued stocks Assist in investment efficiency Gordon Growth Model (Dividend Discount) Zero Growth Normal Growth Preferred Stocks (≈ perpetuities ).

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STOCK VALUATION AND RISK

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  1. STOCK VALUATION AND RISK CHAPTER 11 Dr David P Echevarria

  2. STOCK VALUATION MODELS • The Importance of Efficient Stock Valuation Models • Identify over- or under-valued stocks • Assist in investment efficiency • Gordon Growth Model (Dividend Discount) • Zero Growth • Normal Growth • Preferred Stocks (≈ perpetuities) Dr David P Echevarria

  3. STOCK VALUATION MODELS • Price-Earnings Multiplier (P/E ratio) • Measure of investment attractiveness • Earnings-Price Yield • Factors Affecting Stock Price Movements • Anticipated future earnings • General economic conditions • Interest Rates • Inflationary expectations Dr David P Echevarria

  4. MODERN PORTFOLIO THEORY • Two sources of risk • Variance • Covariance • The Efficient Frontier • Locus of efficiently price securities or portfolios • Securities not on the EF are inefficiently priced Dr David P Echevarria

  5. CAPITAL ASSET PRICING MODEL • Pricing risky assets in market equilibrium • Are Investment A's cash flows correlated with the market [portfolio] M? • The relative volatility (riskiness) of a security is captured by its Beta (B) • The coefficient of correlation, r (rho); degree of co-movement of A and M • Total risk is separated into two components • Diversifiable: individual firm riskiness • Non-Diversifiable risk: the tendency to move with the market (relative risk) Dr David P Echevarria

  6. STOCK MARKET EFFICIENCY • Forms of Efficiency • Weak Form (historical data) • Semi-Strong Form (current news) • Strong Form (insider information) • Empirical Test Results: Is the market a random walk? Can you consistently beat the market? • Weak Form: unexplained volatility suggests market not weak form efficient. • Semi-Strong Form: a number of anomalies have been discerned • Strong Form: insiders can and do successfully beat the market Dr David P Echevarria

  7. GLOBALIZATION OF STOCK MARKETS • International placement of stocks; multi-national market for placement • Integration among international stock markets; magnitude of co-movement varies • International diversification as method of reducing portfolio risk Dr David P Echevarria

  8. HOMEWORK QUESTIONS • What is the difference between the MPT and CAPM in terms of risk measurement? • What are the principal determinants of stock price movements? • What particular problems do under-valued stocks encounter? • Efficient Markets: why necessary, types, Implications of EMH • Why we would include foreign stocks in our investment portfolio Dr David P Echevarria

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