Question

Suppose you are looking for some investment opportunities in the stock market. 1. You observe that Google or Alphabet Inc. (goog) is currently traded at $1133 per share. However, it has never paid any dividends to its shareholders. Your friend concluded that the stock price of google is totally overvalued by applying the dividend discount model. Do you agree? Explain your answer. 2. A portfolio manager recommends you his mutual fund. He claims that the mutual fund he manages obtained a 10%, 6% and 8% return in the past three years, while the market return was only 8%, 4.8%, and 6.4% in the past three years. Based on this information, do you believe this manager is good at picking stocks? If not, what other information do you need?

Answer 1

1. I do not agree with my friend conclusion that Google is overvalued because Google is not to be valued through dividend discount model as Google hs never paid any dividend so dividend discounting model is only discounting those stocks who are paying dividend because dividend discount model will be discounting the futuristic dividend at the present value in order to arrive at the intrinsic value of the share and it cannot value the stock of Google because Google has not paid any dividend so argument of the friend is wrong and I will not be agreeing to him.

2.I will not be believing that manager is good at picking socks because of his outperformance in relation to the index as he may be taking excessive risk and having unnecessary risk exposure which can lead to drawdowns to a larger extent in future years, so I will always be sceptical about his risk exposure and I will be needing his overall portfolio allocation and diversification and I will also be trying to look after his active management strategies which can be lethal at times, if not managed properly.