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■ growth stocks:

Investors buy them in the expectation of capital gain( 資本利得 ). That is, they

are interested in the future growth of earnings rather than in next year’s

dividends.

■ income stocks:

Investors buy them for the cash dividends(現金股利).

■ some terminology(術語、專有名詞):

assumption: Assets are all equity financed. Therefore, assets equal equity.

Balance Sheet

Assets $100 | Equity $100

1) earnings per share (EPS, 每股盈餘) = total earnings/total shares outstanding

**2) cash dividends per share (DIV, 每股股利) = total cash dividends/total shares
**

outstanding

3) payout rate (POR, 股利支付率) = DIV/EPS

**4) plowback ratio (PBR, 再投資比率) = retained earnings/total earnings
**

= (total earnings – total dividends)/total earnings

= 1 – POR

a note: total earnings = total dividends + retained earnings(保留盈餘)

**5) return on equity (ROE, 股本報酬率)
**

= total earnings/total book value of equity(總帳面股本值)

= EPS/BVPS

,where BVPS denotes the book value of equity per share(每股帳面股本值).

**a note: ROE and r
**

ROE is the rate of return on equity investment(帳面股本投資報酬率).

r is the required rate of return on equity( 股本應有報酬率，既股票的

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市 場報酬率 ), i.e., the opportunity cost of equity capital ( 股本資本

的機 會成本).

6) growth rate of assets, earnings, or dividends: g = ROE × PBR

**notes: 1) If all of the earnings were plowed back( 再 投 資 ) into the firm,
**

equity (or assets) will grow at the rate equal to ROE, i.e., g = ROE.

(股本或資產的報酬率既是成長率。)

2) If a portion of earnings is not reinvested (i.e., is paid out as cash

dividends), equity will grow less than ROE, i.e., g = ROE ×

PBR.

3) Since equity and assets grow by g, earnings and dividends grow

by g too.

■ example: Blue Skies

**● case (1): superior returns on the income plowed back into new plant and
**

equipment (ROE = 20% > r = 12%)

Existing assets (equity) generates earnings per share of $5.0. => EPS1 = $5.0

**The firm pays out 60% of the earnings as a dividend. => DIV1 = $5.0 × 0.6
**

= $3.0.

**The income plowed back into new plant and equipment is 40%. This new
**

equity investment earns a return of 20%. => ROE = 20%.

=> dividend growth rate, g = ROE × PBR = 0.2 × 0.4 = 0.08.

**Therefore, stock price, P0 = DIV1/(r – g) = $3.0/(0.12 – 0.08) = $3.0/0.04
**

= $75.0

● case (2): no income plowed back

What if Blue Skies did not plow back any of its earnings into new plant and

equipment?

**We see: DIV1 = EPS1 = $5.0, g = 0
**

stock price, P0 = EPS1/r = $5.0/0.12 = $41.67

or P0 = DIV1/(r – g) = $5.0/(0.12 – 0) = $41.67.

2

notes: 1) The $41.67 represents the (present) value of earnings from the

existing assets.

2) The rest of the stock price ($75 - $41.67 = $33.33) is the net present

value of the future investment that Blue Skies is expected to make.

**Market-Value Balance Sheet
**

Existing Assets $41.67 | Equity $75

Investment Opportunities 33.33 | Debt 0

$75 $75

**3) The remaining $33.33 is that present value of the superior returns on
**

assets to be acquired in the future. This value is called the present

value of growth opportunities, or PVGO.

**Hence, the stock price is composed by two parts:
**

EPS1

P0 = + PVGO ,

r

and PVGO > 0 if ROE > r.

**● case (3): The forecast return on new equity investment was only 12% (ROE =
**

r = 12%).

g = ROE × PBR = 12% × 0.4 = 4.8%

P0 = DIV1/(r – g) = $3.0/(0.12 – 0.048) = $41.67.

EPS1

notes: 1) P0 = $41.67 = + PVGO = $41.67 + 0

r

PVGO is zero because ROE = 12% = r.

**2) conclusion: Plowing earnings back into new investments does add
**

to value (and, thus, add to the current stock price) if that reinvested

money is expected to earn a higher rate of return (ROE) than the

required rate of return (r).

3) 上期: 投資 office building

期初投資(C0) = $350,000, r = 12%

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未來一期的 payoff (C1) = $400,000

=> NPV = C1/(1+r) - C0 = 400,000/(1+0.12) – 350,000 = $7,143 > 0

The return on the investment is:

**(400,000-350,000)/350,000 = 50,000/350,000 = 1/7 = 14.29%
**

> r = 12%.

**Thus, the positive NPV indicates that the new investment earns a
**

higher rate of return (14.29%) than the required rate of return

(12%).

**● case (4): The forecast return on new equity investment was only 8% (ROE =
**

8% < r =12%).

Using this case, can you show that PVGO < 0 if ROE < r?

■ price-earnings ratio (P/E ratio, 本益比)

**● The superior returns on the new equity investment are reflected in the price-
**

earning ratio.

● case (1): ROE = 20% > r = 12%

P/E = P0/EPS = $75/$5 = 15

● case (3): ROE = 12% = r

P/E = P0/EPS = $41.67/$5 = 8.33

**● notes: 1) The P/E ratio is an indicator of firm’s rosy(有希望的) prospects.
**

2) The high P/E suggests that investors think that the firm has good

growth opportunities.

3) However, firms can have high P/E ratios not because the price is

high but because earnings are depressed(壓下、降低).

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6-6 There Are No Free Lunches on Wall Street (Capital Market Efficiency)

■ point: It is not easy to beat the market (make a fortune on the stock market),

and even highly paid pros( 職業選手、專家) find it very difficult to do so

with any consistency(一貫、一致性).

evidence in Figure 6-3:

The average performance of equity mutual funds over 3 decades is compared

to that of S&P 500 index. In 15 years, mutual funds did beat the market.

**implication from the evidence:
**

Many large investors have given up the search for superior investment returns,

and instead they simply buy and hold the market index.

■ two possible ways that you might attempt to beat the market:

**1) technical analysis (技術分析)
**

2) fundamental analysis (基本分析)

■ technical analysis

**● technical analysts (技術分析師):
**

Some investors try to achieve superior returns by spotting( 偵 測 ) and

exploiting( 利用、開發 ) patterns in stock prices (by studying past stock price

movements).

**They might hope to beat the market by buying stocks when they are on their
**

way up and by selling them on their way down.

**● evidence: A large price rise in one period may be followed by a further rise in
**

the next period, but it is just as likely to be followed by a fall.

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Figure 6-4a: S&P 500 weekly returns

rt +1 (return in the following week)

xxx xxx

xxxxxxxxxxx

xxxxxxxxxxxxx

x x x x xxx x x x x x x x x x x

xxxxxxxxxxxxxxxxxx

x x x x x x x x x 0 x x x x x x x x x x x rt (return in week)

xxxxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxx

xxxxxxxxxxxxx

x x xx x x x x x x

x x x xx x

r (correlation coefficient) = -0.02

**notes: 1) the x-axis: the return in this week
**

the y-axis: the return in the following week

2) If a market rise in one week tended to be followed by a rise in the

following week, the points in the chart would plot along an upward

slopping line.

But we see that there was no such tendency; the points are scattered

randomly across the chart.

3) correlation coefficient, r = -0.02: The correlation between the market

movements in successive( 接 連 的 ) weeks is effective zero (i.e., zero

correlation).

4) calculation of correlation coefficient (r):

**01/1955 ~ 04/2002: 47 years and 4 months (2,448 weeks in total)
**

weekly returns: r1 , r2 ,..., rt ,..., r2448

(x, y): ( r1 , r2 ), ( r2 , r3 ) , …, ( rt , rt +1 ), …, ( r2447 , r2448 )

2447 pairs of returns in total

2 vectors of returns:

X Y

6

r1 r2

r r

2 3

r r

t t +1

r2447 r2448

**Then, we can calculate the correlation coefficient in Excel spread
**

sheet.

Several cases are possible:

**case (1): perfectly positive correlation
**

All points ( rt , rt +1 ) show (+, +) or (-, -).

case (2): positive correlation

Most of the points ( rt , rt +1 ) show (+, +) or (-, -).

case (3): perfectly negative correlation

All points ( rt , rt +1 ) show (+, -) or (-, +).

case (4): negative correlation

Most of the points ( rt , rt +1 ) show (+, -) or (-, +).

case (5): zero correlation

Points ( rt , rt +1 ) evenly spread out with (+, +), (+, -), (-, +),

or (-, -).

5) illustration of Excel Function:

= CORREL(A1:A259, B1:B259)

**● random walk (隨機移步):
**

Price changes appear to wander randomly, i.e., virtually( 實 質 上 、 實 際 上 )

equally likely to offer a high or low return on any particular day regardless of

what has occurred on previous days. In other words, price changes seem to

follow a random walk.

Example of a game:

You are given $100 to play a game. At the end of each week, a coin is tossed.

If it comes up heads, you win 3% of your investment; if it is tails, you lose

2.5%.

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t=0 t=1 t=2 t=3

H $109.27

$106.09

H T $103.44

H $103 T H

$100 H $100.43 T

T $97.25 H $97.91

T $95.06

T $92.69

**This process is a random walk because the odds( 機率 ) of making money (an
**

increase) each week do not depend on the changes of the investment in the

previous weeks.

**Figure 6-5: There are two charts in the Figure. One of them shows the
**

outcome from playing the game for 5 years. The other shows the

actual performance of the S&P 500 for a 5-year period.

● predictable cycle (pattern) => self-destruction

Figure 6-6:

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actual price as soon as

upswing is recognized

1,300

1,200

expected upswing of the

9

index

1,100

0 t

2/1 3/1 4/1

last month this month next month

**An upswing( 上 升 ) in the market started last month when the index was
**

1,100 is expected to carry the index to 1,300 next month. As soon as the

cycle becomes apparent(明顯的) to investors, they immediately eliminate (or

destroy) it by their trading.

**● conclusion: Financial economists and statisticians who have studied stock
**

price movement have concluded that you won’t get rich by

looking for consistent(一貫的、一致的) patterns in price changes.

■ fundamental analysis

**● fundamental analysts (基本面分析師):
**

Investors try to gauge( 評 估 ) a firm’s business prospects by studying the

financial press( 報 章 雜 誌 ), the firm’s financial statements, the president’s

annual statements, and other items of news.

**They might hope to make a fortune by buying stocks when they are
**

undervalued( 價值低估的 ) and by selling them when they are overvalued( 價值

高估的).

**● evidence: How stock prices react to one particular item of news – the
**

announcement(宣佈) of a takeover (兼併).

**In most takeovers, the acquiring company( 兼 併 公 司 ) is willing to pay a
**

hefty( 大額的 ) premium( 溢價 ) to induce( 誘導 ) the shareholders of the target

company(目標公司、被兼併公司) to give up their shares.

**The stock price of the target company typically jumps up on the day that the
**

public becomes aware of( 察 覺 ) a takeover attempt( 企 圖 ). However, this

adjustment in the stock price is immediate.

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Figure 6-7: cumulative

abnormal return

28%

12%

0

-120 -15 0 days relative

to announce date

**conclusion: By the time that the acquisition(取得、兼併) has been made public,
**

it is too late to buy.

**Notes: 1) Researchers have looked at the stock price reaction to many other
**

types of news, such as earnings and dividend announcements. All

this information seems to be rapidly and accurately reflected in the

price of the stock, so that it is impossible to make superior returns

by buying or selling after the announcement.

2) abnormal return = actual stock return – expected stock return

ARt = Rt − Rte

The expected return ( Rte ) could be calculated as the return of

similar stocks or the industry return. This abnormal return abstracts

from( 抽 離 ) the fluctuations in the stock price that result from

marketwide( 全市場的 ) influences. Thus, AR could only reflect the

effect of the announcement on the stock return.

3) cumulative abnormal return (累積超額報酬)

t

CARt = (1 + AR1 )(1 + AR2 )....(1 + ARt ) − 1 = [ ∏ (1 + ARs )] − 1

s =1

Example: AR1 = 6%, AR2 = −3%, AR3 = 5%

CAR 3 = (1+0.06)(1-0.03)(1+0.05) – 1 = 1.0796 – 1 = 7.96%

CAR t 反映 announcement 所帶來的累積效果。如果 CAR t 曲線持續上升，

代表正的超額報酬率持續累積。因此，股價必須不斷持續上升，而且上升

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幅度要大過同類股票的上升幅度。

■ efficient market (有效率的資本市場)

**● definition: The prices of capital markets reflect all available( 可 取 得 的 )
**

information.

**=> So, when new information comes out, investors rush to take advantage
**

of it and thereby eliminate any profit opportunities.

● 3 forms of market efficiency(資本市場效率性):

**1) weak-form efficiency:
**

Prices already reflect all the information contained in past prices.

implication: Technical analysis that searches for patterns in past returns is

invaluable.

**2) semistrong-form efficiency:
**

Prices reflect not just the information contained in past prices but all

publicly available information.

implication: It is impossible to earn consistently superior returns simply

by reading the financial press, studying the company’s

financial statements.

3) strong-form efficiency:

Prices impound( 收 集 ) all available information, including those can be

acquired by painstaking( 認真 、努 力的 ) analysis of the company and the

economy.

implication: In such a market, no investors, however hard-working, could

expect to earn superior profits.

**a note: evidence of 3 forms
**

1) Figure 6-4: weak form

2) Figure 6-7: semistrong form

3) Figure 6-3: strong form

■ some puzzles(謎) and anomalies(異常)

● Few simple economic theories are as well supported by the evidence as the

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efficiency market theory. However, there are some apparent exceptions to the

efficient market theory.

● 2 examples of exceptions:

1) the earnings announcement puzzle

**Researchers found that the stocks with the best earnings news
**

outperformed(超越、勝過) the stocks with the worst earnings news by more

than 4% during the 2 months following the earning announcements.

**=> Apparently, stock prices did not reflect all available information at the
**

end of the earnings-announcement days. It seems that investors

underreacted(過低反應) to the earnings announcement.

2) the new-issue(初次發行) puzzle

**Investors bought stock immediately following each initial public
**

offering(IPO, 初 次 公 開 發 行 ) and then held that stock for 5 years. The

investors’ average annual return would have been 33% less than the return

on a portfolio of similar-sized stocks(相同股本大小的公司股票).

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