A Fundamental Approach

Firm Foundation theorists use the fundamental approach to determine the intrinsic value discussed earlier. They look at several main determinants in their analysis of stock prices and future dividends.

Determinant 1: The Expected Growth Rate

Malkiel notes that many newly established coporations perish early. The ones that survive rapidly grow, mature, and then experience a period of stability. However, since it becomes increasingly difficult to sustain growth rates over time, many companies eventually ‘die out.’

Finally, Malkiel gives his First Rule,

• Rule 1:

"A rational investor should be willing to pay a higher price for a share, the larger the  
growth rate of dividends."

• Corollary to Rule 1:

"A rational investor should be willing to pay a higher price for a share the longer the  
growth rate is expected to last."

Determinant 2: The Expected Dividend Payout

• Rule 2:

"A Rational investor should be willing to pay a higher price for a share, other things 
being equal, the larger the proportion of a company's earnings that is paid out in cash 
dividends.""

Determinant 3: The Degree of Risk

Investors prefer less risky stocks and thus these high quality stocks will "command higher price-earnings multiples than their risky, low-quality counterparts." (Malkiel, 79)

• Rule 3:

"A Rational (and risk-averse) investor should be willing to pay a higher price for a share, 
other things being equal, the less volatile are movements in the company's share prices."

Determinant 4: The Level of Market Interest Rates

• Rule 4:

"A Rational investor should be willing to pay a higher price for a share, other things 
being equal, the lower are interest rates.""