Value Of An Investment Based On The Amount Of Risk And Return It Provides

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Stock Valuation In an attempt to determine the value of an investment based on the amount of risk and return it provides, investors often calculate the intrinsic value and compare it to the current market price (Smart et al., 2014). Doing so takes into account the investment’s historical values that are used to estimate the future cash streams as well as the present value needed for comparison (Smart et al., 2014). For example, by applying the dividends-and-earnings approach incorporates both the present value of future dividends and price of stock at date of purchase in an attempt to calculate the value of a share of stock (Smart et al., 2014). Likewise, by employing the price-to-earning (P/E) approach, the investor can incorporate both…show more content…
While the intrinsic value stands only $0.38 under the market price, Smart et al., (2015) contends one should only invest capital if the intrinsic value is equal or greater than the market price. Conversely, given the forecasted EPS and revenue growth in 2016 from Yahoo Finance (2015a), one can assume Southwest’s current P/E ratio of 15.84 will increase to 17.00 by the end of 2016. Therefore, Appendix D dictates that P/E value ($46.24) is significantly higher compared to Southwest’s market price ($42.74) (Yahoo Finance, 2015d). Although the P/E valuation model has its shortcomings, especially since it is tends to react sensitively in both bull and bear markets, the gap in the intrinsic value and market price signifies the Southwest stock is undervalued and a smart buy (Loth, 2015). Equally, Yahoo Finance’s (2015b) analyst opinion dictates that JP Morgan recently upgraded the company’s stock from neutral to overweight. This upgrade, along with the capital gains growth estimates from analysts, specifies that Southwest’s stock is expected to outperform their industry, sector, and S&P 500 (Investopedia, 2015d; Yahoo Finance, 2015d; Yahoo Finance, 2015a). Investment Recommendation Although fluctuations in the marketplace caused by both current economic and industry trends have played a role in the variability of Southwest’s stock, the
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