One of the traditional methods of check if stock is over or underpriced, or to see the 'intrinsic value' of stock is through CAPM model, also called Capital Asset Pricing Model. It shows how much return is expected for a stock over and above market return. One good thing is that this model considers Risk/Volatility for a share as well, and does not just look at returns over time.
Ke = Rf + (Rm - Rf) * Bj
Here Ke- Required rate of return
Rf- Risk free rate of return
Rm- Market rate
B- Beta- Systematic risk of share
- Rf- Example of risk free rate of return Rf is government securties, government would not run away with your money, and even if they fall short, the will just print the money ;)
- B- Beta is how 'fast' or 'slow' share has moved against market return. Regress or plot the closing stock price against closing market over a year, can be done in excel as well... and you will get the Beta value. Beta is between -1 and +1. Stocks having Beta in opposite direction- good for making portfolio of stocks, so that we are covered for market variation in both directions. Higher the Beta, 'riskier' the stock-> and more return should be expected from the stock considering the risk.
- Rm - Market rate is the rate for the whole market
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