Determinants of PBV ratios

Consider again the model presented in the last chapter for valuing a stock in a firm where the dividends paid will grow at a constant rate forever. In this model, the value of ,, , , , Expected Dividend per share next year Cost of Equity - Expected Growth Rate As a simple example, consider investing in stock in Consolidated Edison, the utility that serves much of New York City. The stock is expected to pay a dividend of 2.20 per share next year (out of expected earning per share of 3.30) the...

Small and Lightly Followed Stocks

The persistence of the small stock premium has led many to argue that what looks like a premium in studies comes the failure to allow for transactions costs and to adequately measure risk in firms. There is truth in these arguments, though it is unclear whether the small stock premium would disappear even if they were considered. The transactions costs of investing in small stocks are significantly higher than the transactions costs of investing in larger stocks. The bid-ask spread as a percent...

Serial Correlation

If today is a big up day for a stock, what does this tell you about tomorrow There are three different points of view. The first is that the momentum from today will carry into tomorrow, and that tomorrow is more likely to be an up day than a down day. The second is that there will be the proverbial profit taking as investors cash in their profits and that the resulting correction will make it more likely that tomorrow will be a down day. The third is that each day you begin anew, with new...

Volatility and Default Risk

Stocks that have dropped substantially over the last year are often riskier than other stocks. One reason is that at lower stock prices, volatility increases11. The second is that sudden and precipitous declines in stock prices often increase financial leverage and default risk.12 11 A stock trading at 2 a share will generally have higher percent volatility in prices and returns than a stock trading at 20 a share. There is no theoretical reason for this but it remains an empirical reality. 12...