Stock Valuation and Behavioral Finance Essay Example | Topics and Well Written Essays - 1500 words

Stock Valuation and Behavioral Finance - Essay Example Following formula is used to estimate the price of the stock using dividend growth model: Growth of the stock is calculated using the dividends paid by Shell since 2008 and it is shown in the appendix 1. Discount rate is calculated using the CAPM equation which is as follows: Rf = 4% Rm = 0.59% B = 0.078 So, using the above equations Re is found to be 3.9997% So, the price of the stock using the values identified is 84.86 The current price of shares of Shell is 2,246.5 however the estimated price is 84.86 which is well below. Price to Earnings (P/E) Ratio is the other technique used to estimate the price (Gitman, 2003). Price to earnings ratio is the market price of the company with the earnings per share. The higher value of P/E ratio shows that the investors are paying more for per unit of income they are getting from the share and it can be said that the stock is more expensive (McLaney, 2009). To estimate the price, earnings per share is taken from the annual report of Shell. Pri ce 2,246.50 EPS 4.98 P/E Ratio 451.104 So the price is 2,246.50 and PE is 451.1. However, if the estimated price is considered to calculate the PE ratio then it is 17.04 P/E ratio of the company is very high and it indicates that the shares of Shell are very expensive. However important reasons for this would be that Shell is an important player in the market and investors are eyeing stocks of Shell for investment purpose, so with higher demand the price of Shell’s stock is high. Part 2 – Individual Investors and Sophisticated Investors There are different techniques and valuation methods that investors use to estimate the price of the stock and then make their investment decision. Not all the techniques would give the same kind of results; however these techniques are helpful in giving a signal or a hint to the investors. Investors have different aspects and factors to consider while making the investment decision. Investors have different socio-economic background, q ualification, believe, emotions. Moreover, differences in race and age of investors also influence the investment decision and therefore the decision of one investor could differ from other investor and this has been the main role of behavior finance i.e. to define and discuss why people are not only concerned about the market decisions but they have their own perception and opinion and judgment as well while making the investment decision. Behavior finance has been defined as the study of how people understand and take actions on the financial information they have in making investment decisions (Simon, 1987). Every investor would like to earn higher return on his investment however he or she needs to define his or her risk tolerance level, goals of the investment and other factors that could influence the decision. Different investment and stock valuation techniques are used by investors and it is up to the investor to choose which technique he or she would like to use to make the investment decisions. Some would prefer using PE ratio whereas others would like to use PEG ratio. Some would fancy going for Gordon Growth Model whereas others would like to analyse the previous price and identify the ‘hi and low prices’ and believe that the stock price would go in the same way as in the last few years. Even after using different techniq