chapter 11 note - Omar M. Al Nasser, Ph.D., MBA. Visiting...

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Omar M. Al Nasser, Ph.D., MBA. Visiting Assistant Professor of Finance School of Business Administration University of Houston-Victoria Email: alnassero@uhv.edu Chapter 11 Stock Valuation and Risk Outline Stock Valuation Methods Price-Earnings (PE) Method Dividend Discount Model Adjusting the Dividend Discount Model Free Cash Flow Model Determining the Required Rate of Return to Value Stocks Capital Asset Pricing Model Arbitrage Pricing Model Factors That Affect Stock Prices Economic Factors Market-Related Factors Firm-Specific Factors Integration of Factors Affecting Stock Prices Role of Analysts in Valuing Stocks Analyst Conflicts of Interest Inside Information Unbiased Analyst Ratings Services Stock Risk Measures of Risk Applying Value at Risk Methods of Determining the Maximum Expected Loss Deriving the Maximum Dollar Loss Common Adjustments to the Value-at-Risk Applications Forecasting Stock Price Volatility and Beta Methods of Forecasting Stock Price Volatility
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Forecasting a Stock Portfolio’s Volatility Forecasting a Stock Portfolio’s Beta Stock Performance Measurement Sharpe Index Treynor Index Stock Market Efficiency Forms of Efficiency Tests of the Efficient Market Hypothesis Foreign Stock Valuation, Performance, and Efficiency Valuation of Foreign Stocks Measuring Performance from Investing in Foreign Stocks Performance from Global Diversification International Market Efficiency POINT/COUNTER-POINT: Should the Market Rely on Analyst’s Opinions? POINT: Yes. Analysts specialize in recognizing when a stock is under- or overvalued. They are more skilled than most investors. They also have better access to information than investors. COUNTER-POINT: No. Even if analysts have better skills and information, they tend to offer overly optimistic projections. They are subject to major conflicts of interest and are unwilling to provide negative reports of stocks. WHO IS CORRECT? Use the Internet to learn more about this issue. Offer your own opinion on this issue. ANSWER: The counter-point was proven correct during 2002 and 2003, based on numerous cases. However, the Sarbanes-Oxley Act may force analysts to offer more unbiased opinions. In addition, there are some analysts who are willing to offer honest evaluations, but it is difficult to identify the analysts that are not subject to conflicts of interest. Questions 1. Price-Earnings Model. Explain the use of the price-earnings (PE) ratio for valuing a stock. Why might investors derive different valuations for a stock when using the price-earnings method? Why might investors derive an inaccurate valuation of a firm when using the price-earnings method? ANSWER: Investors can value a stock by applying the industry PE ratio to the firm’s expected earnings for the next year. This method implicitly assumes that the growth in earnings in future years will be similar to that of the industry.
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This method has several variations, which can result in different valuations. For example, investors may use different forecasts for the firm’s earnings or the mean industry earnings over the next year. The previous year’s earnings are often used as a base for forecasting future earnings, but the recent
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chapter 11 note - Omar M. Al Nasser, Ph.D., MBA. Visiting...

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