WVU 2 discussion post – Description
please respond to two of my classmates post based off this prompt.
First, spend a couple of sentences summarizing the Concepts in Action video you watched this week. Then, answer the following. In the Concepts in Action video you watched this week, the speaker mentioned, “A stock is fundamentally more difficult to value than a bond, because it’s less quantitative.” Why do you think this is so (think about intrinsic vs. market value)?
1. The following explains the necessary components for estimating equity shares’ valuation, including assumptions and best estimates.
Profit and loss statement and balance sheet historical and projected: The underlying reality that forecasts are based on many assumptions, which leads to futuristic Sales, Gross Margin, position on Receivables, Payables, Inventory, and other current assets and liabilities, results in future or predicted free Cash-flow.
The weighted average cost of capital calculation: The combination of equity, debt, and other financial arrangements determines this. The weighted average is based on the assumption of Beta, which reflects the equity volatility risk. It is worth noting that if the Beta composition is more significant than one, the WACC will be greater.
Assumptions for calculating Terminal Value or Perpetuity: This includes beliefs about the growth rate, the EBITDA margin (which provides for various expenditures), working capital, the infinity of capital expenditures, income tax rates, etc. Perpetuity can be calculated as free cash flow x (1 + growth rate) divided by the difference between WACC and growth rate. In other words, if the growth rate is projected to be high, the stock value will be increased. On the other hand, if the WACC is large, the stock price would be low.
I think that due to a lack of material information, computing the fundamental value of the share is more complex. On the other hand for bonds, as they have a fixed rate of interest and its cost to the company is simple to compute.
2nd post
In this lesson’s “Concepts in Action,” Catherine Collins-Lang discusses her experience with stocks and highlights the difference between stocks and bonds. She mentions that stocks represent ownership in a company, and their value is determined by the residual value left after the company’s obligations are paid off. On the other hand, bonds are contractual agreements with set cash flows and have a higher priority in receiving payments compared to stocks. Collins-Lang states that valuing stocks is more challenging than valuing bonds because it involves qualitative factors and making assumptions. In contrast, bond valuation is more quantitative and relies on contractual cash flows.
Stocks are more difficult to value than bonds primarily due to their nature as ownership shares in a company. The value of a stock depends on various factors, such as the company’s profitability, growth prospects, competition, and market sentiment. These qualitative aspects introduce more uncertainty and subjectivity into the valuation process, as multiple assumptions must be made. On the other hand, bonds have more predictable cash flows and specific contractual terms, making their valuation more straightforward and quantifiable.
In summary, the difficulty in valuing stocks compared to bonds arises from the qualitative nature of stock valuation and the need to make assumptions about a company’s future performance. In contrast, bond valuation relies more on quantifiable contractual cash flows and market risk assessments.
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