Abdelghani Youmni

STOCK MARKET
EQUITY MARKET
1 STOCKS/SHARES
WHAT ARE SHARES
 Share capital or capital stock refers to the portion of firm’s equity that has been buyed by trading
stock to shareholders fort cash or an equivalent on capital value
 A share is a right to a specified amount of the share capital of a company, corrying with certain
liabilities and right
 Share is not a negotiable instrument or security like bonds, but it is a movable property
 A share of stock is a claim on assets and the income of the firm

Abdelghani Youmni
 Stockholders have ownership interest in the company equal to shares owned
 The share’s interest is measured by the number of shares he is holding and the amount paid him
to the company on shares

2
KIND OF SHARES
Shares Characteristics
Equity Shares - Not fixed rate dividend
- Dividend is paid after dividend after a fixed rate is paid on preference
shares
- Equity shareholders have voting rights
- Claim on asstes
- Limited liability

Abdelghani Youmni
Preference Shares - Fixed rate of dividend
- Priority as to payment dividend
- Preference as to repayment of capital during liquidation of the company
- Preference shareholders haven’t voting rights
Deferred Shares - Rate of dividend is not fixed, it depends upon of the profit
- Dividend is paid after payment of dividend on equity and preference
shares
- At the liquidation of the company, capital on these shares is returned
after capital is repaid on both preference and equity shares

3
MARKET ANOMALIES

- the information does not create stock prices but their course creates the
the market anticipates or information
does not anticipate - big operators can influence a security or stock market value
- the economic prospects of small countries can influence stock prices
- the stock market anticipation is stronger more immediate when the
economy is recovering

Abdelghani Youmni
the market is irrational - the increased attitudes of market players lead to their irrationality
- not all stakeholders benefit from the same information
- when greed dominates economic reasoning can be totally sidelined
the market has a memory - stock market players have a memory and thus the market too
- like the economy the stock market also undergoes cycles
- the cycles of the economy: Kitchin (ups and downs separated by 14
months, ; Juglar (ups and downs separated by 9,2 year); Kondartieff (ups
and downs separated from 48 to 54 years)
- The cycles of the stock market has three movements: primary (several
years); secondary (one or more months); tertiary (euphoric or exaggerated
phase compared to the real economic value of the action, its duration is
less than three weeks) 4
CAUSES OF VOLATILITY

-Fear is the reason because of which an investor can see to avoid losses
Fear Factor -Fear of loss makes the investor vary defensive which results into selling
- Fear factor on the stock market is usually the cause of the sheep effect and
sales in cascades
-Risk taker believes that market is going to be rise and there is positive

Abdelghani Youmni
Double –Dip Worries signal in the market
-The risk averse feels that market can sink any time
- Mixed reactions in the equity market make it more volatile
-Monetary policy has a positive influence on the stock market, while fiscal
Changes in Economic policy has a very negative influence
Policy - The quantitative easing programme is positively received by tke investors
and the market

-Market reacts negatively to any major economic crisis

Economic Crisis -For fear of loss, most of the investors start selling, and only few people take
this as an opportunity to buy
-Investors don’t go for fundamental and technical analysis of their portfolio 5
instead they just got influenced by the negativity of economic crisis
THE PRICE EARNING RATIO
-The P/E ratio is the current market price of a stock divided by its earnings per share (EPS)
-They are many definitions of the P/E ratio: This is the P/E found in the newspapers or the trailing P/E
divides the current price by the reported EPS from the latest fiscal year

Price Per Earning Ratio = Price Per Share / Earning Per Share

Abdelghani Youmni
Example:
As of the end of 2017 Bank of America Corporation closed the year with the following:
Stock Price = $29.52
EPS = $1.56
P/E = 18.92 or $29.52/$1.56

6
HOW TO CALCULATE THE STOCK VALUE

-the value of stocks at any point in time equals the present value of all future dividends
-The value of a stock = Present Value (PV) of all expected future cash flows
-PV0 = D1/(1 + r)1 + D2/(1 + r)2 + D3/(1 + r)3 + . . . forever. . (Dt common stock dividends, r
discount rate)
- Investors and shareholders have to estimate future dividends

Abdelghani Youmni
7
HOW TO CALCULATE THE STOCK VALUE: PROJET DIVIDENDS

Hamsphire products will pay a dividend of $4 per share a year from now.Financial analysts
believe that dividends will rise at 6 percent per year for the foreseeable future. What is the
dividend per share at the end of each at the first of five year?

End of 1 2 3 4 5
year

Abdelghani Youmni
Dividend $4.00 $4 x(1.06) $4 x(1.06)2 $4 x(1.06)3 $4 x(1.06)4

Result $4.00 $4.24 $4.4944 $4.7641 $5.0499

- If dividend are expected to grow at a constant rate, the price of a share of stock is :

P0 = Div/(1+r) + Div (1+g)/ (1+r)2 + Div (1+g)2 / (1+r)2 + ……….. = Div/ ( r-g)

- Where g is the growth rate, Div is the dividend on the stock at the end of the first period

8
HOW TO CALCULATE THE STOCK VALUE: STOCK VALUATION

Suppose an investor is considering the purchase of a share of the Utah Mining Company (UMC). The
stock will pay a $3 dividend a year from today. This dividend is expected to grow at 10 percent per year (
g=10%) for the foreseeable future. The investor thinks that the required return (r) on this stock is 15
percent, given her assessment of UMC’risk,
What the price of Utah Mining Company?
We assess the price to be $60 :

Abdelghani Youmni
P0 = Div/ ( r-g) = 3/ ( 0,15-0,10= = $60
Today’s price P0 is quite dependent out the value of growth (g), if g had been estimated to be 12,5%, the
value of the share would have been :

P'0 = Div/ ( r-g) = 3/ ( 0,15-0,125)= = $120

The stock price doubles from $ 60 to $120 when g only increases 25 percent from 10% to 12,5%. The
stock price P'0 dependency on g . For many companies, steady growth in dividends is an explicit goal.
9
HOW TO CALCULATE THE STOCK VALUE: WHERE DOES GROWTH COME FROM?

 The dividends grow at the rate g

 Consider business whose earnings next year are expected to be the same as earnings this year unless a
net investment is made
 Tis situation is quite plausible because net investment is equal to gross or total investment depreciation
 If total investment is equal to depreciation, the firm’s physical plant is just maintained consistent with
no growth is earnings

Abdelghani Youmni
 Net investment will be positive only if some earning are not paid out as dividends, that is only if some
earnings are retained. This leads the following equation :

Earnings next year= Earnings this year + (Retained Earnings this year x Return on Retained Earnings*)
*: RORE

10
HOW TO CALCULATE THE STOCK VALUE: EXAMPLE

 ABC, Inc. has paid a 1% dividend to common shareholders over the past five years and has steadily
increasing earnings per share (EPS). Sally wants to evaluate ABC’s growth potential by looking at return
on retained earnings. She adds up the previous five years of EPS ($1.00)
 $1.30; $1.50; $1.70; and $2.00). Then, she adds up the annual dividend paid in those years ($0.01; $0.13;
$0.15; $0.17; and $0.20). Sally uses the following formula to find ABC, Inc.’s return on retained earnings
over the past five years.

Abdelghani Youmni
 RORE = ($2.00 – $1.00) / ($7.50 – $0.66) = $1.00 / $6.84 = 14.62%
 Sally sees that the return on retained earnings is just under 15%. She compares that with other companies
in the sector and sees that ABC, Inc. is generating a decent RORE and likes the continued growth
prospects of the company.

11
HOW TO CALCULATE THE STOCK VALUE: EARNINGS GROWTH

 Pagemaster Entreprises just reported earnings of $2 million. The firm plans to retain 40 percent of its
earnings in all years going forward.In other words, the retention ratio is 40 per cent. We also say that 60
percent of earning will be paid out as dividends. The ratio of dividends to earning is often called the payout
ratio. The payout of Pagemaster is 60 percent
 This historical return on equity (ROE) has been 16 percent, a figure expected to continue into the future.
How much will earnings grow over the coming year?

Abdelghani Youmni
 The firm will retain $ 800 000 = ( $ 2 millions x 40%)
 Assuming that historical ROE is an appropriate estimate for future returns, that anticiapted increased in
earning is : $ 800 000 x 0.16 = $ 128 000

12
PRICE-TO-EARNINGS RATIO

 A stock’s price-to-earnings ratio is, as the name suggests, the ratio of the stock’s price to
its earnings per share
 For example, if the stock of Sun Aerodynamic Systems (SAS) is selling at $27.00 per share
and its earnings per share over the last year was $4.50, SAS’s PE ratio would be (6=27/4.50)
 The P/E looks at the relationship between the stock price and the company’s earnings

Abdelghani Youmni
 The Gordon constant dividend growth is:

P0 = D1/(1+r)1 + D2/(1+r)2 + D3/(1+r)3 + D4/(1+r)4 +……..+ Dn/(1+r)n

= D (1+g) /(1+r)1 + D (1+g) /(1+r)2 +……………….+ D (1+g) /(1+r)n
0 0 0
= ∑ D (1+g)t /(1+r)t
0
P0 = D0 (1+g)/r-g = D1 / r-g , where P0: purchase price of the stock;Dt: dividend for the year;
r: discount rate, namely required rate of return; t: the year for dividend payment

13
PRICE-TO-EARNINGS RATIO

 On a particular day in September 2014, The Wall Street Journal reported Google’s PE ratio to be 30. On
that same day, IBM’s PE was 12, Hewlett-Packard’s was 13, Apple’s was 16, and Microsoft’s was 17. Why
would different stocks in the same industry trade at different PE ratios? Do the differences imply that
Google was overpriced and IBM was underpriced? Or are there rational reasons for the differences?

Abdelghani Youmni
14
WHAT IS EQUITY
Liabilities
Equity Bank 500 000
Assets Equity 250 000
€250000
Shares Deposit 250 000
€250/share

Number of Idea

Abdelghani Youmni
shares
1000

Managerial knowldge

Money
€250000
RESTAURANT
Buying machines 15
€1000000
 EXAMPLES 1:

Investors believe that the company will be able to next year, a dividend of 2 euros per share will be paid.
They also anticipate a share price could rise to 80 euros in one year. The rate of return
required for a placement of the same risk class is 8%.

1)What should be the value of the stock today (fundamental value)?

Abdelghani Youmni
2) Determine dividend yield and return on investment

1) The value of the stock today (fundamental value): V0 = (D1/1+r) + (V1/1+r) = (2/1,08) +(80/1,08)=75,93 =

2) Dividend yield and investment profitability :

- Dividend yield = 2/5793 = 2,63%
- The expected value is 80-75,93= 4,07 ; The capital gains rate is 4,07/75,93 = 5,36 %
-The return on investment is 5,36% + 2,63% = 7,99%

16
 EXAMPLES 2:

In mid-2016, the dividend per share (DPA) forecast for Air Liquide is below:
2017 : 2,46 ; 2018 : 2,68 ; 2019 : 2,96 ; 2020 : 3,21

The expected growth rate of dividends from 2020 is 4%. The rate of return demanded by shareholders is 8.04%

Abdelghani Youmni
What is the value of this stock given market forecasts?

The value of this stock given market forecasts:

V0 = (2,46/1,0804) + 2,68/(1,0804)2 + 2,96/(1,0804) 3 + 3,21/ (1,0804) 4 = 69,92

17
 EXAMPLES 3:

Mr. Durand is a seller of 75 Peugeot shares which he does not own on the first market at 800 euros (option of
selling). On the day of the sale, the Peugeot title is only worth 650 euros.
Mr. Durand must he acquire the 75 shares?

 Mr. Durand sell the 75 shares that he acquire at 650 euros.

Abdelghani Youmni
 The total gain is 75x (800 – 650 ) = 11 250 euros
 the selling option technique is used when the operator hopes to make a future gain in a next
transaction, it generates costs and ask for anticipation

18
 EXAMPLES 3: CALCULATE THE PRICE EARNING RATIO

the value of a share is 500 euros, the earnings per share (EPS)are: EPS1= 10, EPS2 =25, EPS3 = 50

PER = stock price / EPS = Value of share / EPS ( PER1 = 500/10 =50; PER2= 500/25 = 20; PER3= 500/50 =10

Expected Yield = EPS/stock price

Abdelghani Youmni
*EY1 = 10/500= 2% low level of yield, high risk
*EY2 = 25/500 = 5% correct level of yield, low risk
* EY3 = 50/500 = 10% stock below it’s real value

19