# Under Valued and Over Valued Stocks

I am not able to see how to you know if a stock is under valued or over valued based on SML, beta or required return.

For example, in one question it says a stocks Forecasted return is 12% and Required Return calculated using CAPM is 15 %. So the stock is over valued and plots below SML.

Could someone please explain why it is over valued?

Because it earns less risk adjusted return than another stock with simillar risk exposure.

The forecasted return is lower than the required return. Using the inverse relationship between prices and returns, you can conclude that the forecasted price must be higher than the intrinsic value (price associated with the CAPM return). The stock is overvalued.

You expect stock A to earn a return of \$5.00 over the next year. If the SML says it should return 5%, then it should be priced at \$100/share (\$5 / \$100 = 5%). If the expected return is 4%, then its price _ is _ \$125/share (\$5 / \$125 = 4%); itâ€™s overpriced by \$25/share.