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Session 6 - NSV
Session 6 - NSV
Session 6 - NSV
1
30017 1 Corporate Finance
Session 6 Equity valuation
Topics
Trading stocks
Valuing stocks
Reading
BMA 4
• Preferred stocks
› Preferred stocks have no voting rights, but pay dividends (typically less
volatile than those paid for common stock)
Source: Worldbank
• This is always true, even if investors buy stocks not just for
dividends but for capital gains
Div1 P1 - P0
Expected Return = r = +
P0 P0
Practice question
• Current Price P0=100, and expected to pay Dividend $5.
• Dividends increase 10% per year, capitalization rate is 15%.
Div1 Div2 DivH + PH
P0 = + + ... +
1
(1+ r ) (1+ r ) 2
(1+ r )H
For each holding period H, compute:
• Present value of cumulative dividends
• Present value of terminal price, pH
100
100 62639.15
You can check that the following formula is always true, i.e. for
any horizon period H:
H
DIVt PH
P0 = 100 = t
+ H
t=1 (1+ r ) (1+ r )
30017 25 Corporate Finance
Session 6 Equity valuation
DIV1
P0 =
r-g
• ! We can use this formula only when g<r
30017 27 Corporate Finance
Session 6 Equity valuation
DIV1
P0 =
r-g
• Reverse and obtain an estimate of the cost of equity:
DIV1
r= +g
P0
• Proof
› If payout ratio fixed over time, dividend growth rate should be equal to
earnings growth rate.
- DIVt=payout ratio*Earningst => gDIV=gEarnings
• Proof
› If payout ratio fixed over time, dividend growth rate should be equal to
earnings growth rate.
- DIVt=payout ratio*Earningst => gDIV=gEarnings
› If ROE fixed over time, earnings growth rate should be equal to Book equity
growth rate
- ROE(%)=Earningst/BookEquityt => gEarnings=gEquity
• Proof
› If payout ratio fixed over time, dividend growth rate should be equal to
earnings growth rate.
- DIVt=payout ratio*Earningst => gDIV=gEarnings
› If ROE fixed over time, earnings growth rate should be equal to Book equity
growth rate
- ROE(%)=Earningst/BookEquityt => gEarnings=gEquity
› By construction,
Equityt+1 = Equityt + (1- payout)* Earningst = Equityt + (1- payout)* ROE * Equityt
Equityt+1 - Equityt
Þ = (1- payout)* ROE
Equityt
Plow-back
Year2
Plow-back
Year3
Plow-back
…
Plow-back … … …
…
Plow-back … … …
…
• “Growth stocks” are stocks for which PVGO represent a large share of the
current price.
› In other words, when large fraction of market value comes from NPV of
future investments