Reviewer-Stock Valuation

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QUICKNOTES REVIEWER ON STOCK VALUATION

BY: ATTY. IVAN YANNICK SAROL BAGAYAO CPA, MBA

STOCK VALUATION

VALUATION OF STOCKS

Stock Valuation is the process of determining a stock’s intrinsic or “true”


value using acceptable mathematical or computational models. Stock
valuation is a necessary step in identifying whether a stock is currently
undervalued or overvalued to determine an acceptable course of action.

Methods of Stock Valuation

A. Non-discounted Techniques - The valuation of stocks may involve a


computation based, summarily, on financial statements and fundamental
market information.

1. Book Value or Net Asset Value Approach


The net asset value or book value approach utilizes the total
shareholders’ equity portion of the financial statements. The objective
of this approach is to determine the Net Asset Value Per Share or the
Book Value Per Share which ultimately represents the equity or the
value of each ordinary share.

The formula for the book value or net asset value approach is:

���� ����� �� ��� ����� ����� ��� �����


����� �ℎ���ℎ������' ������ (�� ����� ������ − ����� �����������)
=
������ �� ����������� �ℎ����

2. Price-Earnings Relative Valuation Approach


In the valuation of a company in target, the prevailing Price-Earnings
Ratio (or also called the Price-Earnings Multiple) of similar or
comparable entities is utilized to determine the value of the target stock.

The computation of the value of the stock using this approach can be
illustrated using this formula:

��������� �����
= ��� ������
× �� ����� �� �� �������� �� ������� ���������

��������� �����
����� �� ����� =
��. �� �������� �hares ������ ��� �����������

B. Discounted Techniques - The most common valuation techniques


involve the consideration of future cash flows that may generated from

1
QUICKNOTES REVIEWER ON STOCK VALUATION
BY: ATTY. IVAN YANNICK SAROL BAGAYAO CPA, MBA
such stock. Considering that the computations may involve future cash flows,
appropriate discounting should be made to place these future cash flows to its
present value.

1. Discounted Dividend Model


This model takes into consideration the expected cash flows of
investment in stocks which are dividends and stock price upon sale.
Simply put, the value of the stock depends on the present value of all
the dividends and the price of the stock once it is sold.

a) Zero or No Growth – A situation where a stock and its


dividends does not grow. This is a characteristic of preferred
shares.

Formula for the valuation of zero or no growth stock is



�� = �
; where
P0 = stock price today
D = dividends
r = required rate of return or cost of equity

b) Constant Growth – A situation where a stock and its dividends


grow at a constant rate throughout its life.

Formula for the valuation of constant growth stock is


�1
�� =
�−�
; where
P0 = stock price today
D1 = dividend at the end of the year
r = required rate of return of cost of equity
g = growth rate

c) Supernormal or Non-constant Growth – A situation where a


stock and its dividends grow at a different rate at the earlier part
of its life. Such growth shall terminate at a horizon or terminal
date where the stock and its dividends begin to grow at a
constant rate.

Formula for the valuation of supernormal or non-constant growth


stock is
�1 �2 �3 ��� ��
�� =
(1+�)
+
(1+�)2
+
(1+�)3
+⋯+
(1+�)��
+
(1+�)��
; where

P0 = stock price today


TD = terminal date or horizon (which is the end of the
non-constant growth phase)

2
QUICKNOTES REVIEWER ON STOCK VALUATION
BY: ATTY. IVAN YANNICK SAROL BAGAYAO CPA, MBA
D1 to DTD = represent dividends to be received during the
non-constant growth phase
TV = terminal value (collection of constant growth phase
dividends)

Formula for terminal value is



�� = ��+1 ; where:
�−�

g = growth rate under constant growth phase


r = required rate of return

2. Corporate Valuation or Free Cash Flow Model


This model computes a company’s market value based on the present
value of the company’s free cash flows. Upon determination of the
market value of the company, the long-term debt and preferred share
capital is deducted leaving the market value of the common stock to be
divided by the number of outstanding common shares to determine the
stock’s intrinsic value.

The discounting concepts are very similar to that of the discounted


dividend model, however with some new elements:

�� – stock price today


������ – market value of the firm
������+��������� – market value of debt and preferred stock
���� – free cash flow at the end of year 1
���� – weighted average cost of capital
� – growth rate
�� – terminal date or horizon
�� – terminal value
��� – outstanding common stock

The relevant formulas are:

��� = ���� 1 − ��� ���� + ������������ ��� ������������


− [������� ������������ + ∆��� ������� �������]

Zero or no growth firms:

���
������ =
����

Constant growth firms:

3
QUICKNOTES REVIEWER ON STOCK VALUATION
BY: ATTY. IVAN YANNICK SAROL BAGAYAO CPA, MBA
���1
������ =
���� − �

Non-constant growth firms:

���1 ���2 ���3 �����


������ = + 2
+ 3
+⋯+
(1 + ����) (1 + ����) (1 + ����) (1 + ����)��
��
+
(1 + ����)��

To determine the stock price:

������ − ������+���������
�� =
���

A. First Meter Investment Company expects to pay a P3.00 per share


dividend to its common stockholders at the end of the year. The dividend is
expected to grow 25 percent a year until {t = 3}, after which time the dividends
is expected to grow at a constant rate of 5 percent a year (D3 = P4.6875 and
D4 = P4.921875). The stock’s Beta is 1.2, the risk-free rate is 6% and the
market rate of return is 11%.

1. What is the company’s current stock price?


A. P12.13
B. P59.05
C. P79.32
D. none of the above

2. From the preceding number, what is the stock’s dividend yield today?
A. 6.35%
B. 7%
C. 11%
D. 5.08%

1. �� = ��. ��

�� = �� × � + ��
�� = ��. �� × �. ��
�� = ��. ��

�� = ��. ����

�� = ��. ������

4
QUICKNOTES REVIEWER ON STOCK VALUATION
BY: ATTY. IVAN YANNICK SAROL BAGAYAO CPA, MBA
� = �� + � �� − ��
� = �% + �. � ��% − �%
� = ��%

��
�� =
� − ��
��. ������
�� =
��% − �%
�� = ���. ����

�� �� �� ��
�� = + + +
(� + �) (� + �)� (� + �)� (� + �)��
��. �� ��. �� ��. ���� ���. ����
�� = + � + � +
(� + ��%) (� + ��%) (� + ��%) (� + ��%)�
�� = ���. ��

��
2. ��� ����� = ��
��. ��
��� ����� =
���. ��
��� ����� = �. ��%

B. The last dividend paid by Insecurity Bank (IB) was P1.00. IB’s growth rate
is expected to be constant for 5% for 2 years, after which dividends are
expected to grow at a rate of 10% forever. SB’s required rate of return is 12%.
What is the current price of IB’s common stock?
A. P50.16
B. P2.68
C. P62.45
D. P47.77
�� = �� × � + ��
�� = ��. �� × �. ��
�� = ��. ��

�� = �� × � + ��
�� = ��. �� × �. ��
�� = ��. ����

�� = �� × � + ��
�� = ��. ���� × �. �
�� = ��. �����

5
QUICKNOTES REVIEWER ON STOCK VALUATION
BY: ATTY. IVAN YANNICK SAROL BAGAYAO CPA, MBA
��
�� =
� − ��
��. �����
�� =
��% − ��%
�� = ���. ����

�� �� ��
�� = + +
(� + �) (� + �)� (� + �)��
��. �� ��. ��� ���. ����
�� = + � +
(� + ��%) (� + ��%) (� + ��%)�
�� = ���. ��

C. BenTen Corporation has projected Earnings Before Interest and Tax (EBIT)
for the next year of P600 million, with tax rate of 40%, Projected depreciation
expense, capital expenditures and increase in working capital for the next
year of P100 million, P200 million and P120 million, respectively. The capital
structure of the company is 40% for debt and 60% for equity. Its cost of equity
is 12 percent while cost of debt (YTM) is 11.66%. The company’s free cash
flow is expected to grow at a constant rate of 6 percent a year.
3. What is the market value of the company?

A. P9,500,000,000 or P9.5 billion


B. P3,500,000,000 or P3.5 billion
C. P1,400,000,000 or P1.4 billion
D. P2,333,333,333 or approximately P2.333 billion

4. From the preceding number, if the market value of debt and preferred
stock is P1 billion and the stock price is P62.50 per share, what is the
number of outstanding shares?

A. 40,000,000 shares
B. 136,000,000 shares
C. approximately 21,333,333 shares
D. 6,400,000 shares

3. ��� = ���� � − ��� ���� + ������������ ��� ������������ −


[������� ������������ + ∆��� ������� �������]
��� = ���� ������� � − ��% + ���� ������� − [���� �������
+ ���� �������]
��� = ���� �������

���� = �� � − � �� + �� ��
���� = ��. ��% � − ��% ��% + ��%(��%)

6
QUICKNOTES REVIEWER ON STOCK VALUATION
BY: ATTY. IVAN YANNICK SAROL BAGAYAO CPA, MBA
���� = ��%

����
������ =
���� − �
���� �������
������ =
��% − �%
������ = ��, ���, ���, ���

������ −������+���������
4. �� = ���
������ − ������+���������
��� =
��
��. � ������� − �� �������
��� =
���. ��
��� = ��, ���, ��� ������

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