Investments: Analysis and Management, 12th Edition

chapter 10

Common Stock Valuation

The moment you have been waiting for is almost at hand. Having prepared yourself to manage your inheritance by dealing with the numerous issues you have now reviewed, whether it be mutual funds, or selling short, or basic portfolio theory, or the CAPM, what you really want to do is what most people are dying to do—get out there and buy some stocks. After all, you know someone who bought Cisco in the 1990s at $20 and it went to $90, and you know for sure this person is not the brightest bulb in the chandelier. On the other hand, you have read all the horror stories about the folks who bought the technology stocks which subsequently collapsed, if indeed they even survived—and some of these people were surely smart. So there must be more to it than meets the eye.

Once again you decide you have to bite the bullet, this time learning the principles of stock valuation. The bad news, as you are about to learn, is that valuation is an art and not a science—it requires judgment as well as skill. The good news is that learning the basic principles of valuation, while not a guarantee of success, will in fact give you an advantage over many investors who simply act on tips or jump in without doing adequate analysis.

How do investors typically go about analyzing stocks to buy and sell? Chapter 10 concentrates on the valuation of common stocks, while Chapter 11 concentrates on how investors should analyze and manage their equity holdings. Here we consider the ...