Unit 5: Stock Valuation, Ratios, and Financial Markets

Vocabulary practice flashcards focusing on stock valuation formulas, market multiples, equity classifications, and financial market structures.

Maximize the Value of the Firm

The overarching financial management objective guiding corporate investment, financing, and dividend decisions.

The Investment Decision

The corporate management decision to allocate capital to assets generating a return higher than the minimum discount rate, reflecting cash flow magnitude, timing, and investment risk.

The Financing Decision

The corporate management process of finding the optimal mix between cheaper debt (which risks financial distress) and more expensive equity (which carries less distress risk) to fund business operations.

The Dividend Decision

The corporate choice of when and how much cash should be returned to business owners via dividends or share repurchases rather than being reinvested in new capital projects.

Dividend

A direct cash payment distributed from corporate earnings to shareholders as cash income.

Capital Gain

The cash return earned by a shareholder from selling equity shares at a market price higher than the original purchase price.

Zero Growth Stock Valuation

The valuation of equity that pays a constant, fixed dividend payment forever, calculated as an ordinary perpetuity using the formula $P_0 = \frac{D}{R}$.

Dividend Growth Model (Gordon Growth Model)

A stock valuation model that prices common stock whose dividends are expected to grow perpetually at a constant rate $g$, calculated as $\hat{P}_0 = \frac{D_0(1+g)}{R - g} = \frac{D_1}{R - g}$.

Dividend Yield

The expected cash dividend for the upcoming period divided by the current stock price, represented algebraically as $\frac{D_1}{P_0}$.

Capital Gains Yield

The expected rate at which the stock price appreciates, which equals the perpetual dividend growth rate $g$ under constant growth assumptions.

Required Total Return ($R$)

The discount rate required by investors on equity, which under the constant growth model equals the sum of the dividend yield and the capital gains yield: $R = \frac{D_1}{P_0} + g$.

Two-Stage Dividend Growth Model

A stock valuation technique used when dividends experience an initial phase of non-constant or abnormal growth before settling into a constant perpetual growth rate indefinitely.

Price-Earnings (P/E) Ratio

A market value ratio computed as price per share divided by earnings per share ($\text{EPS}$), measuring how much investors are willing to pay for each dollar of current earnings.

PEG Ratio

A market value ratio that adjusts the $P/E$ multiple for future growth by dividing the firm's $P/E$ ratio by its expected earnings growth rate percentage.

Price-to-Sales (P/S) Ratio

A market value multiple comparing share price to sales per share, commonly used as a valuation alternative when a company generates negative net earnings.

Market-to-Book (MTB) Ratio

A valuation ratio comparing the market value of a firm's equity investments to their historical accounting book cost, where values below $1$ suggest a failure to create stockholder value above investment cost.

Valuation Using Multiples

An equity valuation method where an estimated stock price is obtained by multiplying a benchmark ratio (such as a peer median $P/E$) by a company metric: $P_t = \text{Benchmark PE} \times \text{EPS}_t$.

Time-Trend Analysis

A financial benchmarking method evaluating how a specific firm's financial metrics and performance ratios evolve chronologically through time.

Peer Group Analysis

A benchmarking method that compares a firm's ratios against direct competitors or industry peers, typically categorized by SIC or NAICS industry classification codes.

Common Stock

Corporate equity ownership with residual claims on assets and earnings without dividend or bankruptcy priority, typically conferring voting rights on board elections and major corporate events.

Proxy Voting

A formal grant of authority by a corporate shareholder permitting another individual to cast their votes on corporate ballots and director elections.

Dual-Class Stock

An equity capital structure featuring two or more distinct classes of common shares possessing disproportionate voting rights or distinct conversion privileges, such as Berkshire Hathaway Class A and Class B shares.

Preferred Stock

A hybrid equity instrument that takes priority over common stock for dividend payments and bankruptcy liquidation, usually pays a stated cumulative dividend, and does not carry voting rights.

Cumulative Dividends

A legal condition on preferred equity requiring that all skipped or unpaid past preferred dividends must be satisfied completely before any common dividends may be distributed.

Primary Market

The financial market where corporations raise capital directly from the public or private investors by issuing and selling brand-new equity or debt securities.

Secondary Market

The market environment in which pre-existing corporate shares are traded directly between public investors without providing direct funds or capital to the issuing firm.

Dealer

A market intermediary who holds an active inventory of securities, buying from investors at the bid price and selling at the higher ask price to profit from the bid-ask spread.

Broker

A market intermediary who connects buyers and sellers without holding security inventory or bearing price risk, earning revenue strictly through execution commissions.

Bid-Ask Spread

The difference between the higher price at which a dealer will sell a security (ask) and the lower price at which they are willing to purchase it (bid).

New York Stock Exchange (NYSE)

An auction-based stock exchange established in $1817$ that utilizes Designated Market Makers and floor brokers within a hybrid framework where approximately $95\%$ of trade execution is electronic.

NASDAQ

A fully electronic dealer market founded in $1971$ (National Association of Securities Dealers Automated Quotations System) that algorithmically matches orders through a central limit order book without a physical exchange floor.

Dow Jones Industrial Average (DJIA)

A price-weighted equity market index tracking the stock performance of $30$ large public industrial firms.

S&P 500 Index

A market-capitalization-weighted stock index that measures the performance of $500$ leading public US corporations based on aggregate firm market values.