Stock Advisor Stock Valuation Techniques 2 — Questions and Answers
Question 1: What is the 'Gordon Growth Model' (GGM) formula?
- Stock Value = EPS / (Required Return – Dividend Growth Rate)
- Stock Value = Dividend / (Required Return – Dividend Growth Rate) (Correct answer)
- Stock Value = Free Cash Flow / (WACC – Revenue Growth Rate)
- Stock Value = Book Value × (1 + ROE)
Correct answer: Stock Value = Dividend / (Required Return – Dividend Growth Rate)
The Gordon Growth Model values a stock as the next dividend divided by (required return minus dividend growth rate), assuming dividends grow at a constant rate in perpetuity.
Question 2: What is 'WACC' and how is it used in stock valuation?
- Weighted Average Cost of Capital — used as the discount rate in DCF models to reflect the blended cost of equity and debt financing (Correct answer)
- Weighted Annual Cash Calculation — used to estimate future free cash flows
- Working Asset to Capital Conversion — used to assess operational efficiency
- Weighted Analyst Consensus Calculation — the average of all analyst price targets
Correct answer: Weighted Average Cost of Capital — used as the discount rate in DCF models to reflect the blended cost of equity and debt financing
WACC blends the cost of equity and after-tax cost of debt weighted by capital structure, and serves as the discount rate in DCF models to compute present value of future cash flows.
Question 3: What is a 'terminal value' in a DCF model?
- The final dividend paid before a company is acquired
- The value of all cash flows beyond the explicit forecast period, representing the majority of DCF value (Correct answer)
- The book value of assets when a company shuts down
- The last reported EPS figure used in valuation
Correct answer: The value of all cash flows beyond the explicit forecast period, representing the majority of DCF value
Terminal value captures the value of all cash flows beyond the explicit forecast period (usually 5–10 years), often representing 60–80% of total DCF value, calculated via perpetuity growth or exit multiple.
Question 4: What is 'price-to-sales' (P/S) ratio used for in valuation?
- Comparing stock price to annual earnings per share
- Valuing companies by comparing market cap to total revenue — useful when earnings are negative (Correct answer)
- Measuring dividend income relative to sales volume
- Comparing stock price to total shares sold in IPO
Correct answer: Valuing companies by comparing market cap to total revenue — useful when earnings are negative
The P/S ratio compares market cap to annual revenue, making it useful for valuing high-growth companies or startups with no earnings yet.
Question 5: What is a 'football field chart' in stock valuation?
- A chart showing stock performance versus a sports team sponsor's stock
- A summary valuation chart showing ranges from multiple methodologies to triangulate a stock's value (Correct answer)
- A chart comparing a stock's volatility to the S&P 500 over a season
- A visualization of a company's revenue sources by geography
Correct answer: A summary valuation chart showing ranges from multiple methodologies to triangulate a stock's value
A football field chart presents valuation ranges from multiple methods (DCF, comps, precedent transactions) side by side, helping analysts triangulate a reasonable value range for a stock.
Question 6: What does a 'sensitivity table' in a DCF model show?
- How sensitive a company's revenue is to marketing spend
- How the stock's intrinsic value changes under different assumptions for key variables like growth rate and WACC (Correct answer)
- A table showing how quickly analysts update their price targets
- How interest rate changes affect a company's bond prices
Correct answer: How the stock's intrinsic value changes under different assumptions for key variables like growth rate and WACC
A DCF sensitivity table shows how intrinsic value changes as key inputs (growth rate, WACC, margins) vary, helping analysts understand the range of possible outcomes and key risk drivers.
Stock Advisor Stock Valuation Techniques 2
What is the 'Gordon Growth Model' (GGM) formula?