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Over the last ten years the average annual return on a stock was 14.7%. Your friend...

Over the last ten years the average annual return on a stock was 14.7%. Your friend decides to buy this stock today knowing she will earn 14.7% for the next year. Evaluate your friend's decision to buy this stock.

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Answer #1

The decision is not theoretically sound. The decision should depend on the comparison between required return (return commensurate with risk) and expected return and not on past historical return. If the required return is less than 14.7% then buy the stock otherwise do not buy the stock. And secondly past returns is no guarantee of future returns. So even if the stock has given average 14.7% for past 10 years there is no certainty that the returns next year will also be 14.7%, it might be less it might be more, depending upon economy, company's financials/management etc.

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