Q2 Topic: Price vs. Value
- Please read the following article for Question 2:
- Price vs. Value
Question 2: You might have heard so many times that the goal of financial management is to maximize the current value (price) per share of the existing stock of a company. In addition, it is widely known that “by maximizing the value of the stock, the value of the company will be maximized as well.” Based on your answer to Question 1, what is your opinion on the sentence highlighted above? Do you agree (or disagree) and why?
Discussion 1 Q2
Price vs Value
The stock value can be determined by a variety of factors such as the company’s past and present earnings along with the projected future earnings of the company and its market share. The Total revenue of the firm or the sales value or the vital ratios such as the Debt-equity ratio, and P/E ratio are also some factors that affect the value of a stock. To determine the stock value, we can use the CAPM approach. CAPM or the Capital Asset Pricing Model studies the relationship between the expected return and the systematic risk of investing in a certain stock. It determines the expected ROI after taking into consideration the cost of capital and the risk attached to those assets (Kiran & Sindhuja, 2020). The CAPM model tries to express a relationship between the risk of the investor investing in a particular stock and the expected return on that particular portfolio.
The diagrammatic representation of the CAPM establishing a relationship between the core aspects of investing in a stock i.e. the investor’s risk and the expected rate of return can be shown as under:
According to the figure above, it can be seen that with an increase in the risk associated with a particular portfolio, the return is also increasing above the risk-free return.
The stock price is related to the stock value. It is the value arrived considering the changes such as the rise or fall in the stock value. The price of a stock is affected by the demand and supply of a given stock at a said time. The price will increase if the demand for a particular stock exceeds the supply of the said stock and vice versa (James, 2019).
The investors are mainly concerned with the stock value than the stock process because of its frequent changing behavior but it is part of the concern of the traders trading in the stock exchange. The preference of the investors differs from one another. Some prefer more risk while others prefer less risk. The main aim of the investors is to maximize their benefits considering their risk and return preferences. They need to take their investment decisions by carefully analyzing the risk-return ratio in a portfolio. By risk diversification, the investors prefer the CAPM for determining the expected return and the variance (systematic risk as determined by Beta) associated with the portfolio, they are interested to invest in.
James, R. G. (2019). Stock Market Volatility and Mathematical Expectations. Available at SSRN 3453911.
Kiran, T., & Sindhuja, K. A STUDY ON VALUATION OF SELECTED STOCKS WITH REFERENCE TO CAPM.