Question

A stock has a beta of 1.112. Calculate its expected return via CAPM. E[rmkt] 0.095 0.10396 rf 0.015 This stock has a current price of $20 per share, with a consenus "target" price of $25 per share. Calculate the expected return implied by the price and target, assuming it pays no dividends. Does the stock offer +alpha or -alpha? Would you buy it or not? Explain.

Answer 1

expected return (CAPM) = rf + (beta * (E[rmkt] - rf))

expected return (CAPM) = 0.015 + (1.112 * (0.095 - 0.015))

expected return (CAPM) = 0.10396, or 10.396%

expected return implied by the price and target = (target price - current price) / current price

expected return implied by the price and target = ($25 - $20) / $20  

expected return implied by the price and target = 25%

The stock offers +alpha. This is because the expected return implied by the price and target is higher than the expected return via CAPM. Therefore, I would buy the stock