Equity Valuation

If an individual were given $100,000 to investment in three different company’s stocks, how does one approach with his or her selection? Expect return from stock investment comes along with extend degree with risks depending on the type of stock invested. Investors seek return from stock investments in two forms: cash dividend and difference between the selling price and purchasing price, known as the capital gains or loses. This paper is to demonstrate how and why three company’s stocks were chosen to include in the $100,000 investment portfolio, and at what market prices would these stock be sold.

Industry Selection

The first step in choosing the stocks is to decide investing in either income stock or growth stock. As Ross, Westerfield, and Jeffe (2004) mentioned, a firm that pays all the earning to stockholders as dividend is referred as a cash cow. Not retaining part or all the earning and plowing back to the firm is not always the most optimal choice; firm that decides to pay out all its earning is missing the its growth opportunities to invest in other profitable projects. Investors who are seeking cash dividend prefer income stocks, as oppose to growth stocks are related to investors’ capital gains and lose. Stocks from matured industries, such as utilities and banking are refer to as income stock because stockholders generally receive a streams of dividends. This form of return from stocks is similar to return from bonds, which involves less risk than growth stocks. Investors that choose growth stock are not promised with dividend return; instead the return comes from the capital gain when the selling price of the stock is higher than original purchasing price. Growth stocks are more prone to risks since the return depends on the firms’ actual growth and market fluctuation. The common belief in risk reduction is to diversify the investment portfolio. Gibson (2004) advocated the one-third-investment strategy. He believes to reduce equity risk; investors ought to spread investments among common stock, real-estate investment, and bond. Using his suggestions to diversify types of investment as a risk reduction tool, each of the three stocks chosen for the investment portfolio must possess one of the following characteristics: