Stock Valuation Analysis | Park Street Holdings

Park Street Holdings Stock Valuation Analysis

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Question

Karissa Grossklaus recently joined an investment banking firm as a research analyst. One of the partners asks her to determine whether a certain stock, Park

Street Holdings, is overvalued or undervalued, and by how much (expressed as percentage return). Grossklaus runs a regression and finds the following information on the stock:

Grossklaus reports that Park Street Holdings stock is:

Answers

Explanations

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A. B. C. D.

C

To determine whether a stock is overvalued or undervalued, we need to compare the expected return (or holding period return) and the required return (from

Capital Asset Pricing Model, or CAPM).

Step 1: Calculate Expected Return (Holding period return):

The formula for the (one-year) holding period return is:

HPR = (D1+ S1"" S0) / S0, where D = dividend and S = stock price.

Here, HPR = (0 + 55 "" 45) / 45 = 22.2%

Step 2: Calculate Required Return:

The formula for the required return is from the CAPM:

RR = Rf+ (ERM"" Rf) * Beta -

Here, we are given the information we need except for Beta. Remember that Beta can be calculated with: Betastock= [covS,M] / [2M]. Here we are given the standard deviation of the market, so the calculation is: 1.30 / 0.752= 2.31.

RR = 4.25% + (12.5 "" 4.25%) * 2.31 = 23.3%.

Step 3: Determine over/under valuation:

The required return is greater than the expected return, so the security is overvalued. The amount = 23.3% - 22.2% = 1.1%.

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