Developing an efficient portfolio of stocks can seem daunting. The journey begins by understanding one’s financial objectives and associated appetite for risk. To assist with the development of the efficient portfolio numerous financial models and evaluation tools are available. These tools can lend insight into positive net present value (NPV) opportunities based on current conditions. These tools also assist with developing a portfolio capable of diversifying away the idiosyncratic risks.
Investors can identify value within the market however this value does not last long. Competition to realize a positive NPV brings the stock back into sync with the rest of the market. This adjustment is known as the efficient market hypothesis (Berk & DeMarzo, 2011). This hypothesis suggests the average investor will have a difficult time identifying positive NPV opportunities. To do this would require unique information the rest of the investment community has yet to learn (i.e. Insider information). The average investor is capable of developing a portfolio that offers the greatest return opportunities based on their aversion to risk. Higher risk (i.e. more speculative opportunities) requires greater payback to make them attractive versus low risk opportunities.
This assessment will evaluate two stock evaluation models; dividend discount and discounted free cash flow. The models will be applied to General Electric’s stock based on current information taken from Yahoo Finance on March 5, 2014. This evaluation will conclude with a discussion of differences between the two models and why these models lead to different estimates regarding value.
Assessment
General Electric (GE) is a global company serving customers in mor...
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... because it is so far removed from the current efficient market trading price. This illustrates the importance of having multiple methods at an investor’s disposal to avoid costly outcomes. If the true value was close to $83 the market would quickly swarm to buy up outstanding shares bringing the stock back into equilibrium.
Works Cited
Berk, J., & DeMarzo, P. (2011). Corporate finance: The core, second edition. (2nd ed.). Boston, MA: Prentice Hall.
Reuters - general electric. (2014, March 5). Retrieved from http://www.reuters.com/finance/stocks/companyProfile?symbol=GE.N
Yahoo finance. (2014, March 5). Retrieved from http://finance.yahoo.com/q;_ylt=AsSsPsK1mlhURru84yZxWVqiuYdG;_ylu=X3oDMTBxdGVyNzJxBHNlYwNVSCAzIERlc2t0b3AgU2VhcmNoIDEx;_ylg=X3oDMTBybHFhOHFvBGxhbmcDZW4tVVMEcHQDMgR0ZXN0AzUxMjAxNQ--;_ylv=3?uhb=&fr=uh3_finance_vert_gs&type=2button&s=GE
Based on the Terminal P/E and the cost of equity I made a sensitivity analysis chart through which I came up with a price of $33.37. This chart shows the different price ranges of the stock which could be possible if the Terminal P/E went higher or lower compared to the Cost of Equity.
Berk, J., & DeMarzo, P. (2011). Corporate finance: The core, second edition. (2nd ed.). Boston, MA: Prentice Hall.
If you pick the wrong stock, you risk losing the value of your investment. Similarly, firms that perform poorly cannot afford to keep the same amount of
However, there is still a significant degree of uncertainty as to the effectiveness of one strategy over another amongst institutional investors and scholars alike. The vast majority of experienced investors believe that diversification, patience, and value are the three columns of successful investing. On the other hand, many researchers are still in disagreement about how viable other strategies such as growth, short-term and concentrated investing can be. Do all successful investors share this common thread of patience, value, and diversification in their investments or are there a plethora of investing techniques that investors utilize to achieve
Parrino, R., Kidwell, D. S., & Bates, T. W. (2011). Fundamentals of Corporate Finance. Hoboken, NJ: John Wiley & Sons. (Original work published 2009)
The WACC model however looks at cash generated and the RM’s profits before tax was £569m (an operating profit of £595m), higher than the required return. Post tax profits where £431m. If we assume investors would desire a higher return than the WACC suggests due the unquantifiable risk, it seems reasonable for a rational investor to consider RM’s shares to be overvalued although not as much as an investor using the dividend model.
...ow valuation has been correctly calculated to show the projected future cash inflow will greater than the present value of the company asset.
The efficient market hypothesis has been one of the main topics of academic finance research. The efficient market hypotheses also know as the joint hypothesis problem, asserts that financial markets lack solid hard information in making decisions. Efficient market hypothesis claims it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information . According to efficient market hypothesis stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments . In reality once cannot always achieve returns in excess of average market return on a risk-adjusted basis. They have been numerous arguments against the efficient market hypothesis. Some researches point out the fact financial theories are subjective, in other words they are ideas that try to explain how markets work and behave.
Brealey, Richard A., Marcus, Alan J., Myers, Stewart C. 1999, Fundamentals of Corporate Finance, 2nd edn, Craig S. Beytien, USA.
In the last few decades, America’s automotive industry has been losing revenue, decline of market share, and employment reduction but international business in the auto industry has been the opposite. For instance, General Motors (GM) have been doing poor in the automotive business while Honda, a Japanese manufacture have been increasing their sales, market shares and employment.
... Capital, Corporation Finance and the Theory of Investment", The American Economic Review, vol. 48, no. 3, pp. 261-297.
The current price of Inuit was $45.900 with a P/E of 29.61. The stock’s fair value using its P/E Ratio was dismal at $24.58. From a fundamentalist view the stock should be sol...
Block, S. B., & Hirt, G. A. (2005). Foundations of financial management. (11th ed.). New York: McGraw-Hill.
Ross, S.A., Westerfield, R.W., Jaffe, J. and Jordan, B.D., 2008. Modern Financial Management: International Student Edition. 8th Edition. New York: McGraw-Hill Companies.