When you are looking at companies with equal risk, which ones will have the highest stock prices?
Question:
Answer:
Depends on Sales, cash flow, Earnings per share and amount of shares outstanding, among other things.
Equal risk, does not mean equal companies or equal value of the stock going forward.
There is no corrolation between risk and price level of a stock. The price level of a stock is determined by other factors such as earnings, dividend, growth rate, overall market sentament, and investor perception.
I think the question that you want to ask is -- which stock will have the better return.
There are two main kinds of risks associated with stocks -- diversifiable risk and nondiversifiable risk. In general, investors are not rewarded for taking on diversifiable risk -- because they can get rid of it by having a well diversified portfolio. However, they demand reward for the non-diversifiable risk. Theories like CAPM (Capital Asset Pricing Model) and APT (Arbitrage Pricing Theory) state that the reward should be a linear function of the undiversiviable risk (or for APT, risks).
So -- the answer to your question is that the one with less diversifiable risk will require a lower return to buy it. If the two firms have the same expected future cash flows -- then the one with the lower expected return (less diversifiable risk) will have the higher valuation. Total valuation is unrelated to stock price, though. A billion dollar company could have a stock price of $10 if there are 100MM shares, while a nearly bankrupt company could have a large stock price if there are only a few shares.
More Questions & Answers...