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Answer please the Questions below in WRITTEN FORM ONLY 7) You are looking to invest in...

Answer please the Questions below in WRITTEN FORM ONLY

7) You are looking to invest in one of three stocks. All other things being equal, Stock A has high expected earnings growth, stock B has only modest expected earnings growth, and stock C is expected to generate poor earnings growth. According to LaPorta's 1996 study, which stock is likely to generate the greatest alpha for you? Why?

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Answer #1

LaPorta (1996) has shown empirically that stocks whose earnings are high about earn poor returns relative to companies whose earnings growth analysts are most pessimistic about.

Stocks with low earnings relative to prices (E/P) and lower book value relative to market value (B/M) are classified as growth (or glamour) stocks since much of the current price is from perceived growth prospects and not current earnings. High E/P and B/M stocks are classified as value stocks and these stocks have low growth prospects since their price reflects current earnings with little premium for growth. This implied growth valuation by investors suggests that investors anticipate continuing improvements in operating performance.

Stock C is expected to have poor earnings growth so has the greatest alpha unlike option stock A and option stock B with higher and modest earnings growth.

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