Question

This is my final paper! I just need a couple paragraphs for each!

1) When regressing Beta manually, you could use daily, weekly, and monthly stock data. Which do you recommend using? What things do you need to consider when making your choice of which time frame to use? What are the issues that can happen when using each of the 3 time frames?

2) When we discussed relative valuation we introduced the ratios P/E, P/S and P/B. Knowing that P/E is the most commonly used of the 3, why would someone choose to use P/S or P/B in valuation? Give as many situations as possible to illustrate your knowledge of relative valuation.

3) Explain the winner’s curse phenomenon and how it affects IPO pricing. Give an example with numbers if possible.

Answer 1

1)

While regressing Beta, it is very important to consider the time frame under consideration. If the time frame under consideration is say 5 years or more , one can take the monthly stock returns, as the data available is statistically significant and more or less normalized over the time period. However if the time frame is less than 3 years, the available sample size is only 36 and thus monthly data is not recommended considering the normality problem. In such cases, a daily or weekly data is preferred. Similarly, if the time frame under consideration is less than 1 year, the weekly data can pose statistical significance and normality problem. In such cases, daily data is preferred over weekly data. For smaller time frames, daily data is the most preferred for regressing returns. Thus, we find that daily returns are the most preferred in any case for finding the Beta of the security.

2)

While P/E is the most common valuation ratio, there are limitations to using this ratio for valuation. One such basic limitation is when the firm does not show profits in balance sheet and only expected to in the near future. In such cases, the sales numbers of industry peers are considered for valuation and P/S ratio is considered. In certain cases, though an industry peer, the revenue model for firms in the same industry can differ, for example subscription model vs upfront payment model. This can have impact sales numbers differently can hence another valuation model needs to be used to compare the industry peers. In such cases, P/B or Price to Book value can be used.