Stock Valuation and Financial Instruments (1)

Investing in the Stock Market: Stock Valuation and Financial Instruments

Student’s Name

Institution’s Name

Date

Investing in the Stock Market: Stock Valuation and Financial Instruments

Table 1:

Bond

Company

Rating

Face Value (FV)

Coupon Rate

Annual Payment (PMT)

Time-to Maturity (NPER)

Yield-to-Maturity (Rate)

Market Value (quote)

Discount/Premium/Par

A-Rated

General Electric Capital Corp

AA

1,000

4%

40.00

10

3.498%

1040.67

Premium

B-Rated

Stillwater NMG Co.

BB

1,000

1.875

18.75

12

2.894%

910.00

Discount

C-Rated

Albertson Inc.

CCC

1,000

8.70

87.00

14

8.536%

1013.80

Premium

Table 2:

Company

5-Year Risk Free Rate of Return

Beta (β)

5 –Year Return on Top 500 Stocks

Required Rate of Return

Apple Inc.

2.43%

0.94

1.09%

14.13%

Intel Corp.

1.28%

0.91

1.09%

13.82%

Cisco Systems Inc

0.83%

1.34

1.09%

19.13%

Table 3

Company

Current Dividend

Projected Growth Rate

Required Rate of Return (CAPM)

Estimated Stock Price (Gordon Model)

Current Stock Price

Over/Under Priced

Apple Inc.

$2.08

11.85%

14.13%

$365

$102.26

Underpriced

Intel Corp.

$1.04

-3.17%

13.82%

$24.45

$31.76

Overpriced

Cisco Systems Inc

$0.84

15.64%

19.13%

$28

$27.86

Underpriced

Table 4:

Company

Estimated Earning (EPS)

P/E Ratio

Estimated Stock Price

Current Stock Price

Over/Under Priced

Apple Inc.

$9.20

11.12

$365

$102.26

Underpriced

Intel Corp.

2.34

13.57

$24.45

$31.76

Overpriced

Cisco Systems Inc

$1.86

14.98

$28

$27.86

Underpriced

Investing in the Stock Market and Stock Valuation

Stocks hold more potential than most investments over the long run. It is reported that stocks have yielded an average annual return in excess of 10 percent since 1962. Purchasing in stock of a company allows one to have a share of the company’s success as well as failure. In the course of the last century, the prices of stocks have been seen to rise or fall subject to a corporate profits or earnings. Although stock prices can temporarily undershoot or overshoot the true value of the stock, ultimately, prices follow earnings. While the potential profit from a stock investment is unlimited, the potential loss is subject to the amount of investment. It should be noted that the price of a stock and consequently the value of one’s investment fluctuates extensively. There are times when the market stagnates in a period of little or no growth and subsequently lower values for stocks. This is referred to as a bear market. On the other hand a bull market refers to a period when stock values are on the increase. There is need to evaluate one’s risk tolerance as well as making stocks a part of well designed investment plan.

There is a wide spectrum of benefits that come with owning stocks whether purchased collectively or individually. Beside their historical value appreciation, stocks can yield income from dividends. Owning stocks has been proven as one of ways to deal with inflation since their returns consistently exceed the inflation rate. It follows hence that when the inflation rises, most corporations transfer their higher costs to consumers thus implying that their profitability as well as the resulting stock prices is seldom affected by inflation. In addition, there is tax benefits associated to owning stocks. It is important to note that capital gains are not taxed until one sells. The capital gains tax rates are often lower than the ordinary income tax rates.

Most investors will agree that the higher the returns are in a certain investment the higher the risks involved. The relationship between risk and returns cannot be overlooked. Safe investments often carry lower risks but on the other hand they have lower returns. They are different level of risks associated with common stock as well as with corporate bonds. while on one hand corporate bonds have lower risk compared to common stock, they offer lowest return among the two, common stock generally have higher risk but higher potential returns on investment (Sandilands, n.d.) .

In corporate bonds the associated risk depends on the performance and financial stability of the company, thus in case of bankruptcy it will be unable to repay the bond value. Common stocks offer higher returns by way of dividends. On the other hand one may also trade the stocks in a stock market at a higher price than the purchasing one (Shangquan, 2000). The risk includes loss of projected profits. If the share price drops below the buying price one may suffer financial loss. Financial statements offer a description of cash inflows as well as outflows for a firm subject to three classes of activities namely; operating activities, investing activities and financing activities. The operating activities generally involve the transactions in the typical business operations of the firm. The investing activities includes the cash flows that result from purchases and sales of securities, property plant and equipment, while financing activities shows the cash flows that ensue from transactions with owners and lenders which are funds received from lenders, contributions of capital owners such as sale of stock, payments of dividends, and payments made to lenders (Florentina-Simona, 2010). Financial and cash flow statements serve as a reticulate of the actual as well as anticipated ingoing and outgoing of cash in an enterprise over a specified period. It evaluates the amount, predictability, and timing of cash inflows and cash outflows and is instrumental in forming the foundation for business planning and budgeting (Hamman, 1994). They allow the provision of information that serves as a tool of evaluating the changes in the net assets of a firm, its financial structure with the inclusion of solvency and liquidity, and its capability to affect the timing and amounts of cash flows in a bid to adopt to the changing business environment and opportunities (Florentina-Simona, 2010).

When buying stocks, investors are interested in financial statements to assess the current earnings as well as to predict future earnings. The financial statements have a considerable influence on the price at which the stock is bought and sold. A ratio is considered to be a quotient of one magnitude divided by another of the same kind. It offers the relation of one amount to another. As regards financial statements, absolute values are usually difficult to conceive and commit to memory. Consequently, amounts in financial statements are often more meaningful when compared to other amounts.

One of the significant ratios of the financial statements is the current ratio. Current ratio is defined as the current assets divided by the current liabilities. This ratio offers an indicator of the ability to pay short-term debt. It is universally agreed upon that this ratio should be greater than 1. Debt-Equity ratio is another significant ratio which provides the measure for the risk assumed in a given business. It should be noted that as the debt capital increases relative to the equity capital, the greater the risk. A high debt-equity ratio implies that when a corporation issues bonds, it will have to pay a much higher interest rate. In the event of stock being issued, investors will require a higher rate of return and may try to attain this higher rate by seeking to buy at a much lower price per share.

Another key performance indicator is the operating ratio. This is the ratio of total expenses and sales. This ratio shows the percentage of sales that ought to be used in paying the expenses. The ratio is not considerably valuable on its own and it makes more sense when compared to past operating ratios whereby a possible trend may be detected. In addition, a company can compare its operating ratio to that of other companies in the industry.

References

Florentina-Simona (2010). Study On the Importance of Cash Flow Analysis Based On Rates In The Financial Decision Making Process. Faculty of Economic and Business Administration University of Craiova. Retrieved from http://feaa.ucv.ro/AUCSSE/0038v2-010.pdf

Hamman W. D. (1994). Cash Flow Statements: The Importance of Cash From Operating Activities- Investing Basics XXIX. University of Stellenbosch Business School. Retrieved from < http://www.iassa.co.za/articles/039_win1994_06.pdf>

Sandilands T. (n.d.) Are Corporate Bonds Riskier Than Common or Preferred Stock? Demand Media. Retrieved from <http://smallbusiness.chron.com/corporate-bonds-riskier-common-preferred-stock-38641.html>

Shangquan G. (2000) . Economic Globalization: Trends, Risks and Risk Prevention. United Nations Development Policy and Analysis Division. Department of Economic and Social Affairs. CDP Background Paper No. 1. Retrieved from <http://www.un.org/esa/analysis/devplan/cdpbackgroundpapers/bp2000_1shangquan.pdf>

http://www.nasdaq.com/symbol/cscohttp://www.nasdaq.com/symbol/intchttp://www.nasdaq.com/symbol/aaplhttps://www.stock-analysis-on.net/NASDAQ/Company/Apple-Inc/DCF/CAPM#Rates-of-Return