Question

Individual student needs to prepare a paper on one reporting issue. The paper shall consists of a proper description of issue, literature review, theory and empirical evaluation of actual companies data. Students are encourage to discuss the forms, types and factors related to the issue. Examples of the issues include (but not limited to):-

1. Write off vs capitalizing In Process R&D especially in technology companies.

2. Gain on subsidiary stock sales.

3. Pushdown accounting

4. Goodwill write-off/impairment – recognition of loss in value, earnings power?

5. The effects of no par value shares.

6. Are impairments relevant for security valuation? And resulting earnings can predict future earnings better?

7. Whether fair value can explain stock price? 8. Use of special or non-recurring items

Answer 1

Whether fair value can explain stock price

Fair Value:

Fair value in accounting, per the International Accounting Standards Board, is the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on a certain date, typically for use on financial statements over time. For fair value in real estate, see Fair Market Value.

It is value determined by the market where the stock is trading, it is generally dependent upon the demand of the stock in the market due to its future financial predictions based upon the current scenario and past performances.

Literature Review:

There are many factors (general as well as specific) which determine whether price of the stock will go up or down. To enlist, some of the common factors are:

• Media reports or rumors
• Opinion of ace investors
• Natural calamities
• Political policies
• Economic condition in the market
• Supply and Demand

Theory:

Trading price of the share in the market is dependent upon the above mentioned factors. However, what drives these factors is the its fair value which can be valued by many approaches.

In a general convention, it is seen that if the fair vlaue of the stock is more than its transaction value than it is prudent to buy it and vice versa. However there is little chance that one can calculate FV of the stock correctly. There is no scientific proven method to calculate it. However there are many approaches like of following PE ratio, growth rate and EPS to evaluate the worth of the share.

One with correct calculations can calculate near about fair value of the stock and than make decision

Actual Company Example

In 2005, Citi Groups share years low of $ 429.10, in 2007 of $ 288 and in 2009 it tanked to $ 9.70 where as EPS was $ 40.90, $ 7.90 and 0 in the period. It can be seen that Company’s stock price actually correlated to its intrinsic value based on earnings throughout its history. In other words, where earnings went, stock price followed, and even more importantly, whenever price deviated, over or under, from fair value, it quickly came back into alignment.