Effect on stock valuation, Financial Management

Effect on Stock Valuation

Until the 1960s, common stocks were viewed as a good instrument against loss caused by inflation. Also, before 1960, stocks were not providing full hedge against the inflation. The only benefit attached with the investment in the common stocks was that their value was not very adversely affected during the period of inflation and their performance was comparatively better. To understand the effect of inflation on stocks' value, we will now try to evaluate the Gordon-Shapiro dividend discount model.

V0 = D0/K - G

Where,

V0 = value at time zero.

D0 = dividends received during time period zero.

K = constant discount rate.

G = constant growth rate of dividends.

According to the supporters claiming that common stocks are good inflation hedging instruments, there will be no change in V0 due to unexpected inflation. This is expected because the discount rate K also increases along with increase in the inflation expectations and the rate of change is almost similar to the dividend growth rate, ‘G'. Hence, the net effect on V0 will be almost zero. However, for this idea to hold good, companies should be able to forward the increase in costs of raw materials, borrowings and taxes in the form of higher selling price of their product.

Stocks are expected to show good gains during periods of unexpected inflation only when companies can increase their selling price at a higher rate than the increase in the cost of materials, labor and other inputs. But, past observed evidence recommends that common stocks have not established themselves as a perfect hedging instrument against unexpected inflation. It is important to mention here that this conclusion is based on a study conducted using pre-tax returns. In fact, the results based on after-tax returns are more remarkable. Now the question arises as to why stocks cannot provide hedging benefit against the unexpected inflation. The real output growth is not resistant to the negative effects of inflation and this ensures that unexpected inflation will damage the value of all the capital assets. Since the income of the common stocks comes mainly from the residual income of the economy, the decline in the value of common stocks is uneven.

 

Posted Date: 9/11/2012 4:53:56 AM | Location : United States







Related Discussions:- Effect on stock valuation, Assignment Help, Ask Question on Effect on stock valuation, Get Answer, Expert's Help, Effect on stock valuation Discussions

Write discussion on Effect on stock valuation
Your posts are moderated
Related Questions
The two main objectives are: To get at a single value: Measures of central value, by considering the mass of data in one single

A company has the opportunity to sell an old machine. The machine is fully depreciated to a zero book value but could be sold for $5,000. If the company did not sell the machine, i

Capitalization ratios are used for determining the extent to which the corporation is trading on its equity, and the resulting financial leverage. These ratios

Question 1: (a). A big multinational company wishes to employ a PR manager for all its PR activities. What according to you would be the advantages and disadvantages of having

stauffer , inc., has estimated sale and purchase requirments for the last half of coming year. parepare cash budget for the month of


Credit analysis is the financial analysis used for determining the creditworthiness of an issuer using various quantitative and qualitative factors. The four Cs an anal

Suppose you can decrease the cash on hand and the company will require holding Net Working Capital (including cash) equal to 4% of the next year's sales going forward.  This will r

Principles of Financial Accounting and Management 1. Define Accounting. Briefly explain the ‘Entity Concept' and ‘Money Measurement Concept' of accounting. 2. What is rectif

Write the format to place the order. What are the risks involved in the delivery of products. Format of the order: ? Purchase order ? Acknowledgement form ? Material requisitio