Stock Trading Stock Trading Fundamental Analysis & Valuation 2 — Questions and Answers
Question 1: What does the Discounted Cash Flow (DCF) model primarily use to value a stock?
- Historical price trends
- Future cash flows discounted to present value (Correct answer)
- Dividend history only
- Market sentiment indicators
Correct answer: Future cash flows discounted to present value
DCF valuation projects a company's future free cash flows and discounts them back to the present using a required rate of return.
Question 2: What is the significance of the current ratio in fundamental analysis?
- It measures profitability margins
- It assesses a company's ability to pay short-term obligations (Correct answer)
- It calculates earnings per share
- It shows revenue growth rate
Correct answer: It assesses a company's ability to pay short-term obligations
The current ratio (current assets ÷ current liabilities) measures short-term liquidity, with a ratio above 1 generally indicating the company can cover near-term debts.
Question 3: Which of the following best describes 'earnings per share' (EPS)?
- Total company revenue divided by shares outstanding
- Net income divided by shares outstanding (Correct answer)
- Operating profit divided by total assets
- Gross profit divided by market capitalization
Correct answer: Net income divided by shares outstanding
EPS is calculated by dividing a company's net income by its number of outstanding shares, indicating profitability on a per-share basis.
Question 4: What does a high Debt-to-Equity (D/E) ratio generally suggest about a company?
- The company uses more debt than equity to finance operations (Correct answer)
- The company has strong earnings growth
- The company pays large dividends
- The company has low operating costs
Correct answer: The company uses more debt than equity to finance operations
A high D/E ratio means the company relies heavily on borrowed money relative to shareholder equity, which increases financial risk.
Question 5: In fundamental analysis, what is the purpose of a SWOT analysis?
- To calculate exact intrinsic value
- To evaluate strengths, weaknesses, opportunities, and threats (Correct answer)
- To measure stock volatility
- To track short-term price movements
Correct answer: To evaluate strengths, weaknesses, opportunities, and threats
SWOT analysis is a qualitative tool that evaluates a company's internal strengths and weaknesses alongside external opportunities and threats.
Question 6: What does 'return on equity' (ROE) measure?
- Total sales relative to assets
- Net income generated per dollar of shareholders' equity (Correct answer)
- Dividend payments to shareholders
- Operating expenses as a percentage of revenue
Correct answer: Net income generated per dollar of shareholders' equity
ROE is calculated as net income divided by shareholders' equity, showing how efficiently management uses equity to generate profit.
Stock Trading Stock Trading Fundamental Analysis & Valuation 2
What does the Discounted Cash Flow (DCF) model primarily use to value a stock?