Final answer:
A stock is considered overvalued when its required rate of return is higher than the return that can be earned from the current price and resulting cash flows. The rate of return is achieved through dividends and capital gains.
Step-by-step explanation:
A stock is said to be over-valued under the following circumstance: the stock has a higher required return (according to the CAPM), than the return an investor could earn by paying the current stock price [and experiencing the cash flows that ownership of the stock produces]. Investors expect to receive a rate of return in two forms: through dividends or through capital gains, where the latter is the increase in the stock's value between when it is bought and when it is sold. For instance, buying Wal-Mart stock at $45 and selling it for $60 is making a capital gain of $15.