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Stock Valuation For Slected Company
Stock Valuation For Slected Company
8-1
Facts about common stock
Represents ownership
Ownership implies control
Stockholders elect directors
Directors elect management
Management’s goal: Maximize the
stock price
8-2
Types of stock market
transactions
Secondary market
Primary market
Initial public offering market
(“going public”)
8-3
Different approaches for
valuing common stock
Dividend growth model
Corporate value model
Using the multiples of comparable
firms
8-4
Terms used in stock valuation
Dt = Dividend expected to receive at the
end of year t.
Po = Actual market price of the stock
today
^
P t = Expected price of the stock at the
end of year t
^
P 0 =Intrinsic or theoretical value
8-5
Terms used in stock valuation
g= Expected growth rate in dividends.
^ D1 D2 D3 D
P0 ...
(1 k s )1 (1 k s ) 2 (1 k s ) 3 (1 k s )
8-7
Constant growth stock
A stock whose dividends are expected to
grow forever at a constant rate, g.
D1 = D0 (1+g)1
D2 = D0 (1+g)2
Dt = D0 (1+g)t
8-9
If kRF = 7%, kM = 12%, and β = 1.2,
what is the required rate of return on
the firm’s stock?
Use the CAPM to calculate the required
rate of return (ks):
8-10
If D0 = $2 and g is a constant 6%,
find the expected dividend stream for
the next 3 years, and their PVs.
0 1 2 3
g = 6%
8-11
What is the stock’s market value?
Using the constant growth model:
D1 $2.12
P0
k s - g 0.13 - 0.06
$2.12
0.07
$30.29
8-12
What is the expected market price
of the stock, one year from now?
D1 will have been paid out already. So,
P1 is the present value (as of year 1) of
D2, D3, D4, etc.
^
D2 $2.247
P1
k s - g 0.13 - 0.06
$32.10
0 1 2 3
ks = 13%
...
2.00 2.00 2.00
^ PMT $2.00
P0 $15.38
k 0.13
8-15
Self testing:1
Cook company is expected to pay a $0.50
per share dividend at the end of the year.
The dividend is expected to grow at a
constant rate of 7% per year. The required
rate of return on the stock,Ks, is 15%.
What is the value per share of the
company’s stock?
8-16
Self testing:2
Dozier Corporation’s share currently sell for
$20 per share. The stock just paid a
dividend of $1 per share. The dividend is
expected to grow at a constant rate of 10%
a year. What stock price is expected 1 year
from now? What is the required rate of
return on the company’s stock?
8-17
Supernormal/Nonconstant growth:
What if D0 = $2 & g = 30% for 3 years
before achieving long-run growth of 6%?
Can no longer use just the constant growth
model to find stock value.
However, the growth does become
constant after 3 years.
8-18
Valuing common stock with
nonconstant growth
0 k = 13% 1 2 3 4
s
...
g = 30% g = 30% g = 30% g = 6%
D0 = 2.00 2.600 3.380 4.394 4.658
2.301
2.647
3.045
4.658
46.114 P3 $66.54
^ 0.13 0.06
54.107 = P0
8-19
Find expected dividend and capital gains
yields during the first and fourth years.
Dividend yield (first year)
= $2.60 / $54.11 = 4.81%
Capital gains yield (first year)
= 13.00% - 4.81% = 8.19%
During nonconstant growth, dividend yield
and capital gains yield are not constant,
and capital gains yield ≠ g.
After t = 3, the stock has constant growth
and dividend yield = 7%, while capital
gains yield = 6%.
8-20
Nonconstant growth:
What if g = 0% for 3 years before long-
run growth of 6%?
0 k = 13% 1 2 3 4
s
...
g = 0% g = 0% g = 0% g = 6%
D0 = 2.00 2.00 2.00 2.00 2.12
1.77
1.57
1.39
2.12
20.99 P3 $30.29
^ 0.13 0.06
25.72 = P0
8-21
Find expected dividend and capital gains
yields during the first and fourth years.
Dividend yield (first year)
= $2.00 / $25.72 = 7.78%
Capital gains yield (first year)
= 13.00% - 7.78% = 5.22%
After t = 3, the stock has constant
growth and dividend yield = 7%,
while capital gains yield = 6%.
8-22
If the stock was expected to have
negative growth (g = -6%), would anyone
buy the stock, and what is its value?
The firm still has earnings and pays
dividends, even though they may be
declining, they still have value.
^ D1 D0 ( 1 g )
P0
ks - g ks - g
$2.00 (0.94) $1.88
$9.89
0.13 - (-0.06) 0.19
8-23
Find expected annual dividend and
capital gains yields.
Capital gains yield
= g = -6.00%
Dividend yield
D1 / P0 = $1.88/$9.89 = 19.00%
0 k = 10% 1 2 3 4
...
g = 6%
-5 10 20 21.20
-4.545
8.264
15.026 21.20
398.197 530 = = TV3
0.10 - 0.06
416.942
8-27
What is market equilibrium?
In equilibrium, stock prices are stable and
there is no general tendency for people to
buy versus to sell.
In equilibrium, expected returns must equal
required returns.
^
D1
ks g k s k RF (k M k RF )
P0
8-28
Market equilibrium
Expected returns are obtained by
estimating dividends and expected
capital gains.
Required returns are obtained by
estimating risk and applying the CAPM.
8-29
What is the Efficient Market
Hypothesis (EMH)?
Securities are normally in equilibrium
and are “fairly priced.”
Investors cannot “beat the market”
except through good luck or better
information.
Levels of market efficiency
Weak-form efficiency
Semistrong-form efficiency
Strong-form efficiency
8-30
Weak-form efficiency
8-31
Semistrong-form efficiency
8-32
Strong-form efficiency
8-33
Preferred stock
Hybrid security
Like bonds, preferred stockholders
receive a fixed dividend that must be
paid before dividends are paid to
common stockholders.
However, companies can omit preferred
dividend payments without fear of
pushing the firm into bankruptcy.
8-34
If a preferred stock with an annual
dividend of $5 sells for $50, what is the
preferred stock’s expected return?
Vp = D / kp
$50 = $5 / kp
kp = $5 / $50
= 0.10 = 10%
8-35