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Chapter 8

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12 views3 pages

Chapter 8

Uploaded by

burnsburner29
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Risk Measurements

Variance & Standard Deviation


- Risk of a stock
o Volatility of price movements

Beta of Stock
- Measure of stock price volatility over a period of time
o Beta = 1: exact same risk as the market average
 Example is ETF on TSX 300 (Exchange trade fund)
o Beta > 1: Risker than market average
 Example is small mining company
o Beta < 1: less risk than market average
 Example is Canadian Bank
o Time period  how long are you using to measure beta
 Example: Beta of apple is 1.1 for last 3 years
o Best beta will be the longest term that reflects the company’s current operations

Correlation
- How the prices of two stocks move compared to each other
o +1 – perfectly positively correlated (Price of two stocks move the same)
 Example: Royal Bank (TSX & NYSE)
o -1 – perfectly negatively correlated (Moves opposite of each other)
 Example: Buy Royal Bank or Short Royal Bank
o 0 – no correlation (Move independently)
 Example: Different industry and geography

Diversification & Risk

Systematic vs unsystematic
- Unsystematic risk – risk associated with a specific stock
- Systematic risk – Risk of the market
o The goal: Stocks with low correlation

Portfolio return and Beta


- Average expected return of a portfolio
o Example: Stock A has an expected return of 70% during an economic boom and -
20% during a recission
o Stock B has an expected return at +10% in a boom and +30% in a recession
o Your portfolio is 50% Stock A and 50% in stock B.
- What is the expected return of the portfolio if there is a 90% chance of recission?
o Boom: E(R) = (.50) (.70) Stock A + (.50) (.10) Stock B
o Recission: E(R) = (.50) (-.20) + (.50) (.30)
o Our scenario? Boom 60% and Recession 40%
 E(R) = (.60) (.40) + (.40) (.05)
Portfolio Beta
- How risky is the portfolio of stocks compared to the market average
o Stock A Holding = .50 Beta = 2.0
o Stock B .50 1.2
o What is the portfolio beta?
 Beta portfolio = ( % holding stock A) (Beta A) + ( % holding stock B)
(Beta B)

DDM
- Value for stock is based on the dividends that it pays
o No growth in dividends
 P0 = Dividend/ R
 P0 – Price of stock today
 Dividend – Annual dividend paid
 R – Expected return on stock
o Constant Growth
 Annual growth of dividend at the same rate forever
 P0 = Div (1) / R – G
 P0 – Price of stock today
 Div (1) – Dividend per share in 1 year from today
 D1 = D0 * (1 + G)
 R – Expected return on stock
 G – Annual growth rate of dividend (constant rate)
o Pros and Cons
 Pros – Easy, Based on cash flow (Dividend)
 Cons – Doesn’t work unless government pays dividends, Growth is not
constant in real life, growth of dividend cannot be greater than R

Multiples
- Value of stock is related to the value of the stock for competitors in the same industry
o Example: How a real estate agent values your house
 Based on actual transaction

- Price to sales
- Price to EBITDA  Earnings before interest, taxes, depreciation, and amortization (Pre-
tax cash flows)
- Price to net income  Price earnings ratio
o PE Multiple
o PE Multiple of 15x
 If income is $1 million, then the value of the company = 15 * $1 million =
15 million
- Rough range is 10x to 30x
Example
- Your company has $100 million in sales. The EBITOA is $10 million and net income
is $6 million. What is the value of your company if competitors in your industry
trade at the following multiples:
o Price to sales = 1x
o Price to EBITDA = 6x
o Price Earnings = 12x
- Values using price & sales = $100 million * 1
- Value using EBITDA = $100 million * 6
- Value using Earnings = $6 million * 12
o Conclusion: Range of values = $60 million to $100 million
o Average of multiples = $77.3 million

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