Msf535 - Jim Cramer’s Mad Money on Cnbc

MSF 535- FINAL EXAM

1. While watching Jim Cramer’s Mad Money on CNBC you notice that company valuation and company market price are used interchangeably. Is this usage correct? If so, why? If not, why?

It’s easy to assume that a company’s stock value would corelate, but that snot always the case. There is a distinction between the two, and its important to know them to make the right investment decision.

While evaluating a company’s value, its essential to look at the fundamentals of the company. Various earning multiples, future projections, their existing market share, their debt to equity ratio are considered, which are further analyzed and then one can arrive at the value. It’s the value that one believes the stock of that company should trade for on the market. The true value of the company can also be computed with different valuation models, like discounted cash flow and comparable company analysis. Its where you review and analyze competitors’ performance and then compare it with the company you are valuing to come up with a price at which the company should be valued. It may be undervalued or overvalued.

As oppose to the value, market price of the company is the price at which the stock is trading at. It fluctuates daily due to rising or falling of the market. The market price of the company is the reflects what buyers and sellers are willing to pay for that company. It may not necessarily be the value of the company.

The fundamental factors do affect the market price over the long term, it’s the supply and demand which affects the stock price in the short term.

Investors are more concerned with the company’s stock value as oppose to trading where the company’s market price is more important.

2. Why can accounting not directly provide us with information necessary to perform cash flow discounting-based valuations?

Discounted Cash Flow is a valuation model used to estimate the value of the company and to see if it’s a viable investment opportunity or not. This model requires to discount the projected free cash flows using a discounting rate to arrive at the present value. This value is then compared to the cost of investment and if its lower, it would be a viable investment opportunity.

The inputs for this valuation model are mainly the projected free cash flows and the discount rate, both of which aren’t available in the financial statements of the company. Accounting is essentially creating materially correct financial statements. It includes the income statement, balance sheet, and statement of cash flows. Though the statement of cash flows helps us to derive the free cash flows, it does not directly provide any necessary information.

Accounting could fill the in the gaps like the capital expenditure, the cash the company has to arrive at the free cash flow, but the process for the projected free cash flows which is essentially the foundation for this method is based on assumptions, key business drivers, and peer performance and not on the financial statements.