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8.1.2 Bottom Up Approach

This is stock picking. Followers of this approach believe that they can select stocks that are under priced and will outperform regardless of the industry and market outlook.

The next step is to look at the valuation of securities and we first need to explain the different types of return.

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Investment returns

The return, or cash flow, can be received by an investor in different forms e.g. earnings, dividends, cash flow, interest payment, capital gains. Valuation models are based on different types of return and more than one model should be used to get an accurate valuation of an investment.

In addition to forecasting the returns themselves, it is necessary to estimate the timing of returns and the growth rate of returns.

We now look at how securities are valued. If the estimated value is greater than the market price, it is a buy signal and if it is lower it is a sell signal.

8.1.2.1 Value of preferred stock

The holder of a preferred stock receives a dividend in perpetuity. The value of a preferred stock is given by

Value = Dividend/ k

Where,

Dividend is the annual dividend paid

K is the investors required rate of return

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