Question

You run a regression of X’ Company stock's returns against the market returns over a five-year time period (using monthly data) and come up with the following output: Intercept = .20%, Slope = 1.20 Your stock had an annualized standard deviation of returns of 40% whereas the market standard deviation was only 20%. The annualized risk-free rate, on average, over the last five years has been 6% and it is currently at 7%. The risk premium = 8.5%. The annualized dividend per share currently is $2.00 and the stock is currently selling for $50 (There are 100,000 shares outstanding) Evaluate the performance of X Company over the five-year time period of your analysis.

Answer 1

EVAULATION OF COMPANY X PERFORMANCE USING REGRESSION MODEL

Here, we are given some useful regression parameters to interpret the performance of Company X.

Let us first understand what a regression equation is,

Regression is a statistical tool to show the impact of independent variable over the dependent variable. It is given by:

where Y is dedepndent variable

X is independent variable

= Intercept

= Slope

Here, The stock return is dependent variable are is represented by Y and Market return is independent variable represented by X.

Regression Equation:

Y=1.20 X + .20

Slope= For every increase in 1% in market returns, there is a corresponding 1.20% increase in company X returns or the stocks returns are 20% more than the market returns.

Intercept= .20 which means when all X is 0, then the expected mean value of Y would be positive .20 which also means that the stock is overperforming the market returns.

Let us now evaluate the company X performance using the CAPM model

In general, The CAPM Model is given as

Where, Rx= Expected return of stock X

Rf = risk free rate

= Beta or slope of cofficient of risk premium over risk free returns

Rm= Market risk premium

Rf is given as 6% of last five years, Rm as 8.5%. , and beta as 1.20

Therefore, Rx= 6%+1.20(8.5%-6%)

Rx= 9%

Thus, we can say that the returns of company X have outperformed the market returns.

Evaluation of Dividend and stock price.

Dividends play an important role for a company since the investors look upon dividends as a source of income as expect the company to pay considerable amount of dividend.

We can evaluate the performance of company X by calculating its dividend yield.

Dividend yield= Annual dividends per share/ price per share

=2/50

=.04

This shows that for every $share owned, the investor will realize $ .04 of returns in the form of dividends.

CONCLUSION

Based on our evaluation, we can say that company X has shown an efficient performance during last 5 years in terms of stock returns and providing dividends to its investors. Though the standard deviation and beta factor of the company is more as compared to the market which also means that the company stocks are at higher risks. This is one thing that the company must take care of in the near furture.