Question

Benjamin Graham, the father of value investing, once said, "In the short run, the market is a voting machine, but in the long run, the market is a weighing machine." In this quote, Benjamin Graham was referring to the key difference between the "price" and the "value" of a security. In November 2006, Citigroup's stock (NYSE: C) was trading at $49.59. Following the credit crisis of 2007-2008 and by the end of October 2009, Citigroup's stock price had plummeted to $4.27. Several banks went under, and others saw their stock prices lose more than 60% of their value. Based on your understanding of stock prices and intrinsic values, which of the following statements is true? The intrinsic value of a stock is based only on the perceived risk in the company. O A stock's intrinsic value is based on the fundamental cash flows and the company's risk. You can estimate the value of a company's stock using models such as the corporate valuation model and the dividend discount model. Which of the following companies would you choose to evaluate if you were using the discounted dividend model to estimate the value of the company's stock? O A company that has been distributing a portion of their earnings every quarter for the past six years. O A company that is in a high-growth stage and plans to retain all its earnings for the next few years to support its growth. Which of the following describe the reason(s) why maximization of intrinsic stock value benefits society? Check all that apply. Stock price maximization requires efficient, low-cost businesses. Most investors prefer companies that can raise prices beyond reasonable levels. Successful companies higher more employees. Successful companies can avoid raising external funds in the financial markets.

Answer 1

The intrinsic value of the stock is based on the return and risk of the company. Therefore, the second option is correct. In the dividend discount model, the price of the stock is estimated by discounting the future dividend payments. Therefore, the correct option is first option, as the earnings are paid out. Maximizing the intrinsic value of the stock helps the society, as the firms provide low-cost goods and services to the customers and acquire a greater number of employees. Therefore, the correct options are option 1 and option 3.