Question: 3. Forecasting stock value Understanding the returns from investing When buying stock, you can expect to earn money through future current income (from dividends )
3. Forecasting stock value
Understanding the returns from investing
When buying stock, you can expect to earn money through future current income (from dividends ) and future capital appreciation (from increases in stock price ). Together, your total earnings from a given investment can be expressed in terms of the approximate yield. This value makes it easier for you to compare investment options.
Understanding the Approximate Yield Equation
The formula for the approximate yield of an investment can look intimidating, but its really just a function of three things: (1) average current income, (2) average capital gains, and (3) the average value of the investment. Based on the information in the table, compute each of these values for the two stocks over a 3-year period and enter the values into the bottom half of the table.
| Stock 1 | Stock 2 | |
|---|---|---|
| Expected average annual dividends (20122014) | $1.25 | $2.95 |
| Current stock price | $70 | $116 |
| Expected future stock price (2014) | $82 | $146 |
| Average current income (CI) | $
| $
|
| Average capital gains (CG) | $
| $
|
| Average value of the investment (VI) | $
| $
|
Next, derive the correct formula for approximate yield by correctly arranging these three variables in the equation that follows.
| Approximate YieldApproximate Yield | = = | Avg. VI + Avg CG | / / | Avg. VI |
Using this formula, you can see that the approximate yield for Stock 1 is and the approximate yield for Stock 2 is .
True or False: If both investments carry the same rate of risk, Stock 1 is a better investment than Stock 2.
False
True
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