Principles of Finance

Learning Goal: I’m working on a finance writing question and need an explanation and answer to help me learn.

I would like you to reply to this peer discussion post. The post reply need to be substantial and constructive in nature. It should add to the content of the post and evaluate/analyze that post’s answer. Normal course dialogue does not fulfill the peer reply.

Every investor who wants to beat the market must master the skill of stock valuation. Fundamentally, stock valuation is a method of determining the intrinsic value (or theoretical value) of a stock. The importance of valuing stocks evolves from the fact that the intrinsic value of a stock may be different from its current price in most successful companies, it is higher than the launching price, and a good example here is Apple and Microsoft. By knowing a stock’s intrinsic value, an investor may determine whether the stock is over- or undervalued at its current market price.

Intrinsic value means to know at the exact point in time what a given company’s worth is. This is to say if I am going to invest by buying stocks during my next adventure. How I would know that I am making the right decision whether to invest in buying stocks of Facebook or Microsoft for example? (Barsky & De Long, 1993)

Calculating the Market Cap, short for capitalization. Is the best way to define the right choice for my next investment? This is occur by multiplying its stock price by the number of shares outstanding. Likewise, any substantial drop in a stock price results in an equal percentage loss in the company’s market cap. For example, a $0.20 fall in a stock price results in $200,000 damage on paper for a shareholder with two million shares. Therefore, it is necessary to understand how to determine if the stock value is above or below the stability rate and what is likely could the fluctuation % that could contribute to profit or loose and when this otherwise could hit. (Ibbotson, 1975)

A major way to first protect investment and secondly withdraw some profit is to know what are the types of stock valuation. There are two ways, absolute and relative.

Absolute, or intrinsic, stock valuation relies on the company’s fundamental information. The method generally involves the analysis of various financial information that can be found in, or derived from, a company’s financial statements. Many techniques of absolute stock valuation primarily investigate the company’s cash flows, dividends, and growth rates. Notable absolute stock valuation methods include the dividend discount model (DDM) and the discounted cash flow model (DCF).

In the relative technique, stock valuation compares the potential investment to similar companies. The relative stock valuation method calculates multiples of similar companies and compares that valuation to the current value of the target company. The best example of relative stock valuation is comparable company analysis, sometimes called trading comps.

Explain the difference between valuing preferred stock and common stock and how to calculate for each. Be sure to support your statements with logic and argument, citing any sources referenced.

The Preferred stock once it’s issued mainly by large companies. Now it is common in SMEs’ privately held companies, too. Preferred stock (also called preferred shares) has to do with a capitalization of a company, bankruptcy restructurings, merging or sale, exchanging preferred shares for debt or other types of equity securities or estate tax planning, or many other reasons. The evaluator must value the preferred shares first and then deduct that value from the entire equity of the entity. The common stocks that exist for an organization are preferred stock and common stock.