Question

1. (Expected Growth Rate and Retained Earnings) Please explain how the expected growth rate of a company is related to the retained earnings.

2. (NYSE vs NASDAQ) Please discuss the difference between the NYSE and NASDAQ markets. Also who are the more recent competitors and why are they important?

3. (NPVGO) What is the NPVGO and why might it be important?

4. (PE Ratio) Why is the Price to Earnings Ratio a good indicator of stock valuations? Why not?

Answer 1

1. The growth rate of a company is related to the retained earnings. Company needs funds to grow its operation and it can either borrow from outsider or retain its earnings and reinvest it to grow. The formula for growth rate is derived from return on equity and multiplied by its retained earnings. Retained earning is that part of total earning which is not paid as dividends to its shareholders Growth rate = return on equity* Retention ratio 2. NYSE stands for New York stock exchange and NASDAQ stands for national association of securities dealers automated quotation. The major difference between NYSE and NASDAQ is NYSE is an auction market whereas NASDAQ is a dealer's market. In an auction market individual typically buy and sell it to each other while in dealer market the participants deal through a dealer. In NYSE, there is normally one market maker while in NASADQ there are more than one market makers. NYSE is more concentrated towards blue chip firms while NASDAQ is more towards internet or tech company. Although these two exchanges are quite big exchange, they do have competitors like ICE, BAT, LSE and in recent years many alternative platforms have come up through which people can trade. The importance of these platform is that they can take away the liquidity from the NYSE and NASDAQ and impact their revenue. 3. NPVGO stands for net present value of growth opportunities. NPVGO is the present value of all the future cash flow associated with the growth opportunities. The importance of the NPVGO lies in the fact that it considers all the future cash flows and helps in calculating the intrinsic value of a stock today. 4. P/E ratio is a relative measure which is calculated as price of the stock divided by the earning per share. The price to earning ratio is a good measure of valuation because it is easy to calculate and compare with the other stocks in the same industry. It also tells you about the growth potential of the stock, generally high P/E ratio stocks are considered to growth stock. P/E ratio might not be a good measure because by the time you get to know that a particular stock is growth stock, the price would have risen. The P/E ratio can be misleading if the earnings are negative.