offer of two stocks

Question

You are offered two stocks.  The beta of A is 1.4 while the beta of B is 0.8.  The growth rates of earnings and dividends are 10 percent and 5 percent, respectively. 

The dividends yields are 5 percent and 7 percent, respectively.

a. since A offers higher potential growth, should it be purchased?

b. since B offers a higher dividend yield, should it be purchased?

c. If the risk free rate of return were 7 percent and the return on the market is expected to be 14 percent, which of these stocks should be bought?

Answer 1

a and b

A has a higher beta, higher growth rate, and lower dividend yield. This implies A is experiencing high growth within the company, and its stock price is expected to increase more over time compared to B. A is suitable for investors seeking capital appreciation. It should be purchased if the investor is willing to lock in money now for future profit.

On the other hand, B is a stock with stable growth. This implies the stock price will remain stable, but its dividend payments will be attractive. B is suitable for investors looking for income supplements. It should be purchased if the investor wants a constant stream of income.

 

c

Under the CAPM model

E(R) = Rf + b(E(M) - Rf)

A: E(R) = 0.07 + 1.4(0.14 - 0.07) = 0.168

B: E(R) = 0.07 + 0.8(0.14 - 0.07) = 0.126

 

Since we are not given information on each stock's actual return, we cannot conclude which stock is more advantageous. Was there more information in the question?