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stock valuation and investment decisions chapter 8 - cfa

stock valuation and investment decisions chapter 8 - cfa


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Tech stocks have been at the forefront of stock market news the

past few years. Often this sector, rather than blue-chip

industrials, drives the market—both up and down. Take

Qualcomm, for example; a company that is a leading developer

and supplier of digital wireless communications products and services.

It pioneered Code Division Multiple Access (CDMA) technology, a

standard for the wireless communications industry. Investors in

Qualcomm stock have experienced a roller coaster ride recently. The

firm’s 1999 stock price started at $6.48 and soared steadily upward to

end the year when it hits $176.13—after splitting 2-for-1 in May and

4-for-1 in December. This represents an annual return of over 2,600%,

the year’s best. The following year was another matter, however. Fears

of slowing growth sent the stock price into free-fall: It plummeted

from $163.25 to $51.50, before rebounding to $82.19 at year end, for

a 53% return. Even after the decline, the stock was still trading at a

price/ earnings ratio of about 85 in early January 2001, a substantial

premium over the average P/ E of 29 for the S&P 500.

Despite Qualcomm’s fluctuating stock price, investors looked with

favor on the company’s earnings growth—94% from 1997 through

2000, which far outstripped the S&P 500’s 14%. The company

consistently met or exceeded quarterly earnings estimates, and

analysts project continued earning growth to $1.26 per share in 2001,

an increase of 48% over 2000.

What do all these numbers mean in terms of the value of

Qualcomm’s stock? This chapter explains how to determine a stock’s

intrinsic value by using dividend valuation, dividend-and-earnings,

price/ earnings, and other models. We also look at how to value

technology stocks. Finally, we’ll review the use of technical analysis as

a way to assess the state of the market in general.

Sources: Adrienne Carter, “The Big Score,” Money Technology 2000, October 15, 2000,
p.60; “Morningstar Quicktake Report—Qualcomm” Morningstar.com, downloaded
from www.morningstar.com, January 15, 2001; and Qualcomm Web site,

C H A P T E R 8



After studying this chapter, you
should be able to:

LG1 Explain the role that a
company’sfuture playsin the stock
valuation processanddevelop a fore-
cast of a stock’sexpectedcash flow.

LG 2 Discuss the concepts of
intrinsic value and required rates of
return, and note how they are used.

LG 3 Determine the underlying
value of a stock using the dividend
valuation model, as well as other
present value– and price/earnings–
based stock valuation models.

LG 4 Gain a basic appreciation
of the procedures used to value
different types of stocks, from
traditional dividend-paying shares
to new-economy stocks with their
extreme price/earnings ratios.

LG 5 Describe the key attributes
of technical analysis, including some
popular measures and procedures
used to assess the market.

LG 6 Discuss the idea of random
walks and efficient markets and note
the challenges these theories hold
for the stock valuation process.

--Gitman2002.CH08.314-368.CTP 7/19/01 12:19 PM Page 314

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