Steve Sharpe: A Stock Report

This case pertains to the valuation approach for a common stock being considered for purchase by a student in a Student-Managed Fund (SMF) class at a university. The fundamental factors of analysis pertaining to the profile of the company include the firm’s products or services, the nature of the demand for the products and the managerial comparisons for sales. In addition, earnings per share, return on sales, return on assets and return on equity are considered. However, historical data on price-earnings ratios and dividend payout ratios are very important in all valuations, but they are not stressed in the case. The emphasis of the case relates to recognition of risk, as it pertains to the common stock of the firm, estimations of the required rate of return (sometimes known as the hurdle rate), calculation of the present value factor which permits analysts to determine the present value of annualized return data projected into a specific future period. A price of the common stock projected into the future can be discounted to compare its present value with the current market price to determine whether the stock is undervalued or overvalued. In like fashion, a holding period return calculated in a time period greater than five years can be annualized for comparison with the required return obtained from an asset pricing model to determine whether the stock is undervalued or overvalued.