From The E Activity: Determine Whether Stock Prices Are Affe

From The E Activity Determine Whether Stock Prices Are Affected Mo

• From the e-Activity, determine whether stock prices are affected more by long-term or short-term performance. Provide one (1) example of the effect that supports your claim. • From the scenario, value a share of TFC’s stock using a growth model method and compare that value to the current trading price of a share of TFC. Determine whether the stock is undervalued or overvalued. Provide a rationale for your response.

Paper For Above instruction

This paper aims to analyze whether stock prices are influenced more significantly by long-term or short-term performance, supported by relevant examples, and to evaluate the valuation of TFC's stock using a growth model. The findings suggest that stock prices are predominantly affected by long-term performance, especially due to the market's tendency to incorporate fundamentals such as earnings growth, financial stability, and strategic direction over time. Additionally, an application of the growth model indicates whether TFC's stock is undervalued or overvalued relative to its intrinsic value, providing investment insights.

Impact of Long-term Versus Short-term Performance on Stock Prices

Stock prices are complex and continually influenced by various factors, but empirical evidence and market theories suggest that long-term performance has a more substantial impact than short-term fluctuations. According to Fama and French (1993), stock prices tend to reflect fundamentals over time, aligning with the efficient market hypothesis's semi-strong form, which posits that current prices incorporate all publicly available information, especially long-term growth prospects.

One clear example of long-term influence is the correlation between a company's enduring financial health and its stock valuation. For example, Apple Inc.'s sustained revenue growth and innovation over decades have historically driven its stock price upward, despite short-term market volatility caused by temporary setbacks or news. This long-term focus of investors—particularly institutional investors—leads to stock prices being more responsive to factors such as earnings growth, innovation pipelines, and strategic expansions over time rather than immediate earnings reports or short-term market shocks.

In contrast, short-term performance, captured through quarterly earnings reports or macroeconomic news, can cause temporary fluctuations but often does not fundamentally affect the long-term valuation unless these signals indicate a significant and persistent change. For example, if a technology company reports a quarterly earnings miss, the stock might decline temporarily, but unless this trend indicates deeper issues, the impact on the stock's long-term valuation is usually limited. Thus, while short-term performance can influence market sentiment in the near term, long-term performance remains a more robust predictor of enduring stock value.

Valuation of TFC's Stock Using a Growth Model

Applying a growth model, such as the Gordon Growth Model (Dividend Discount Model), requires estimating key variables: the expected dividend next year (D1), the required rate of return (k), and the perpetual growth rate of dividends (g). Assume TFC pays a current dividend (D0) of $2.50 per share, with an expected dividend growth rate (g) of 5%. The required rate of return (k) based on market risk and TFC’s risk profile is assumed to be 8%.

The model calculates the intrinsic value (P) as:

\[ P = \frac{D_1}{k - g} \]

Where:

\[ D_1 = D_0 \times (1 + g) = 2.50 \times (1 + 0.05) = 2.625 \]

Thus:

\[ P = \frac{2.625}{0.08 - 0.05} = \frac{2.625}{0.03} = 87.50 \]

This indicates that the intrinsic value of TFC’s stock is approximately $87.50 per share.

Comparing Intrinsic Value to Market Price and Investment Implications

Suppose TFC's current trading price is $80 per share. Since the intrinsic valuation ($87.50) exceeds the market price ($80), the stock appears undervalued, suggesting it may be a good buy, assuming the assumptions about dividends and growth are accurate. Conversely, if the market price were above $87.50, it might suggest overvaluation.

This valuation indicates that the market may be underestimating TFC's growth potential or future earnings stability. Investors might consider that the company's prospects, competitive advantages, and dividend policies support a higher valuation than what the current market reflects, providing a rationale for potential investment.

Limitations and Considerations

It is critical to acknowledge that valuation models rely heavily on assumptions about growth rates and required returns. Changes in economic conditions, interest rates, or company-specific risks can significantly alter these estimates. Furthermore, market prices are also affected by sentiment, macroeconomic factors, and sector-specific trends, which may diverge from intrinsic valuations.

Conclusion

Long-term performance predominantly influences stock prices, driven by fundamental factors such as earnings stability, growth potential, and strategic direction. The valuation of TFC’s stock via the growth model indicates it is undervalued at its current market price, suggesting potential investment opportunity. Nonetheless, investors should consider the limitations of valuation models and monitor ongoing financial and macroeconomic developments.

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