Sunday, November 13, 2011

Equity Valuation models / stock pricing / Shares CFA

Equity Valuation models / stock pricing / Shares CFA
By: Shivgan Joshi

Introduction
Human mind is very strange, you need to give it the right reason to do something. And the very right reason to study this subject is that stocks can help you decide your portfolio, analyze things, nevertheless this is the largest of the topics in level 2. In this regard this becomes a very important topic. The merger and acquisiton price analysis and other very important phenomenon are dependent on how well you understand this area.

Thus this is a thing that you must motivate yourself to understand a lot.

When it comes to picking a price for a share or deciding to play in investment banking this area again becomes very important.

In totality I am trying to develop some interest in this area before we formally move into it.

Various methods are used for various people for valuations. This subject holds 20% and is the most important subject for the CFA Level 2. Hence learning it here will make things in future very easy and interesting.

One thing that took a very long time to understand is the formula for margin with maintenance call, that the last thing in the CFA level 1 which drove me into understanding more. But finally I figured it out. The 2 calls are made to restrict your loss and protect the broker from incurring any loss due to your investment.

Earning multiplier, and role of dividend in the valuation, and linking ratios for valuation of a stock are some the important things.

A very big confusion point here is how to interpret dividend payout ratio and growth in the company with the effect of retaining income. The company with higher retention will cause faster growth.

Another very interesting thing is with divisor when there is stock split in price weighted index. We find out divisor for split for the values before the next one and then use the same divisor which has an embedded weighted effect in itself. There are some examples which you can see.

Now, lets move something called the divisor-for-adjusting-split, in this case we find the divisor of the base year and use the same after the split and the values of stock has changed. In general what we do is that we find the average price of the base, then do the split and put a divisor X so that average price remains the same and find this new divisor. After than we use the same divisor for the new year when the price has changed significantly.

Growth stock, speculative stock and cyclical stock.

Discussion: If payout ratio increases, then PE multiple increases or decreases?

Conclusion: An overview of interesting and deeply engaging topics for equity required for CFA and other similar exams are given.

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