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 to the conclusion of my friend because Google is not to be valued through application of dividend discount model because Google has not paid any dividend and Google is not expected to pay any dividend in future .

Dividend discounting model will be discounting the value of futuristic expected dividend and it will be discounting them at the present in order to arrive at the intrinsic value so Google is not expected to pay any dividend and it cannot be discounted using dividend discounting model in order to find the intrinsic value so the contention of friend is completely wrong as the application of dividend discounting model to Google is not correct.

2.I do not believe the manager is good at picking stocks because of his outperformance in relation to the overall market index because he would have been taking higher risk and he can be prone to drawdowns in future also,so I will be always trying to analyse his risk portfolio and diversification skills along with maximum potential of loss making so I will be trying to analyse various components of his portfolio and risk management skills and active management skills also so I will not be believing just by looking at the return that the manager is good at picking stocks.