Stock Valuation

Reported by:
Paula Hugo
Queency Ganotise
Arvin Daryl Perez
 Stock Valuation
Differentiate between debt and equity.
Debt
• Includes all borrowing incurred by a firm, including bonds, and is
repaid according to a fixed schedule of payments.

Equity
• consists of funds provided by the firm’s owners (investors or
stockholders), and the stockholders earn a return that is not
guaranteed but is tied to the firm’s performance.
Differentiate between Debt and Equity
Differentiate between Debt and Equity

Voice in management
• Unlike creditors, holders of equity (stockholders) are owners
of the firm.

Claims on income and assets

• Equity holders claims on income and assets are secondary to
the claims of creditors.
How are assets divided in bankruptcy?
According to the U.S. Securities and Exchange Commission, in
bankruptcy assets are divided up as follows:
Secured Creditors
• Secured bank loans or secured bonds, are paid first.

Unsecured Creditors
• unsecured creditors loans or unsecured bonds, suppliers, or
customers, have the next claim.
How are assets divided in bankruptcy?

Equity holders
• equity holders or the owners of the company have the last claim
on asset, and they may not receive anything if the Secured and
Unsecured Creditors’ claims are not fully repaid.
Differentiate between Debt and Equity
 Differentiate between Debt and Equity
Maturity Tax Treatment
• Unlike debt, equity capital is • Interest payments to debtholders are
a permanent form of treated as tax-deductible expenses
by the issuing firm.
financing.
• Dividend payments to a firm’s
• Equity has no maturity date stockholders are not tax-deductible.
and never has to be repaid • The tax deductibility of interest
by the firm. lowers the corporation’s cost of debt
financing, further causing it to be
lower than the cost of equity
financing.
 Discuss the features of both
Common and Preferred Stock.
The features of both common and preferred stock

• Common stockholders, who are sometimes referred to as residual

owners or residual claimants, are the true owners of the firm.

• As residual owners, common stockholders receive what is left the

residual after all other claims on the firm’s income and assets
have been satisfied.
Common Stock: Ownership

• Common stock of a firm can be privately owned by a private

investor, closely owned by an individual investor a small group of
investors, or publicly owned by public investors or broad group of
investors.
Common Stock: Par Value

• The common stock in par value is an arbitrary value established

for legal purposes in the firm’s corporate charter and can be used
to fine the total number of shares outstanding by dividing it into
the book value of common stock.
Common Stock: Preemptive Rights

• A Preemptive right allows common stockholders to maintain their

proportionate ownership in the corporation when new shares are
issued, thus protecting them from dilution of their ownership.
There are 2 types of Dilution:

Dilution of Ownership
• Is a reduction in each previous shareholder’s fractional ownership
resulting from the issuance of additional shares of common stock.

Dilution of Earnings
• is a reduction in each previous shareholder’s fractional claim on
the firm’s earnings resulting from the issuance of additional
shares of common stock.
 Common Stock: Authorized, Outstanding, and
Issued Shares

Authorized Shares
• are the shares of common stock that a firm’s corporate charter allows
it to issue.

Outstanding Shares
• are issued shares of common stock held by investors, this includes
private and public investors.
 Common Stock: Authorized, Outstanding, and
Issued Shares

Treasury Stock
• are issued shares of common stock held by the firm; often these
shares have been repurchased by the firm.

Issued Shares
• are shares of common stock that have been put into circulation.
Issued shares = outstanding shares + treasury stock
 Common Stock: Voting Rights
• Each share of common stock entitles its holder to one vote in the
election of directors and on special issues.

Proxy Statement
• is a statement transferring the votes of a stockholder to another party.

Proxy Battle
• is an attempt by a nonmanagement group to gain control of the
management of a firm by soliciting enough proxy votes.
 Common Stock: Voting Rights

Supervoting Shares
• is stock that carries with it multiple votes per share rather the single
vote per share typically given on regular shares of common stock.

Nonvoting Common Stock

• is common stock that carries no voting rights; issued when the firm
wishes to raise capital through the sale of common stock but does not
want to give up its voting control.
 Common Stock: Dividends

• The payment of dividends to the firm’s shareholders is at the

discretion of the company’s board of directors.

• Dividends may be paid in cash, stock, or merchandise.

 Common Stock: International Stock Issues

• The international market for common stock is not as large as that for
international debt.

• However, cross-border issuance and trading of common stock have

increased dramatically during the past 30 years.
 Common Stock: International Stock Issues
Stock Issued in Foreign Markets
• A growing number of firms are beginning to list their stocks on foreign
markets.

• Issuing stock internationally both broadens the company’s ownership base

and helps it to integrate itself in the local business environment.

• Locally traded stock can facilitate corporate acquisitions because shares

can be used as an acceptable method of payment.
Foreign Stocks in U.S Markets
2 types of American Depositary
American Depositary Receipts
• A dollar-denominated receipts for the stocks of foreign that are
held by a U.S financial institution overseas.

American Depositary Shares

• Are securities, backed by American depositary receipts, that
permit U.S investors to hold shares of non-US companies and
trade them in U.S markets.
Preferred Stock

• Preferred stock gives its holders certain privileges that

make them senior to common stockholders.

• Preferred stockholders are promised a fixed periodic

dividend, which is stated either as a percentage or as a
dollar amount.
Preferred Stock
2 types of Preferred Stock
Par-value preferred stock
• is preferred stock with a stated face value that is used with the
specified dividend percentage to determine the annual dollar
dividend.

No-par Preferred Stock

• is preferred stock with no stated face value but with a stated
annual dollar dividend.
Preferred Stock: Basic Rights of Preferred Stockholders

• Preferred stock is often considered quasi-debt because, much like

interest on debt, it specifies a fixed periodic payment.

• Preferred stock is unlike in that it has no maturity date.

Preferred Stock: Features of Preferred Stock

• The restrictive covenants in a preferred stock issue focus on

ensuring the firm’s continued existence and regular payment of
the dividend.

• Restrictive covenants including provisions about passing

dividends, the sale of senior securities, mergers, sales of assets,
minimum liquidity requirements, and repurchases of common
stock.
Cumulation
2 Types of Cumulation
Cumulative
• Preferred stock is preferred stock for which all passed (unpaid)
dividends in arrears, along with the current dividend, must be paid
before dividends can be paid to common stockholders.

Noncumulative
• Preferred stock is preferred stock for which passed (unpaid)
dividends do not accumulate.
Others Features of Preferred Stock
Callable Feature
• Is a feature of callable preferred stock that allows the issuer to
retire the shares within a certain period time and at a specified
price.

Conversion Feature
• Is a feature of convertible preferred stock that allows holders to
change each share into a stated number of shares of common
stock.
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Issuing Common Stock
• Initial financing typically comes from its founders in the form of a
common stock investment.

• Early-stage debt or equity investors are unlikely to make an

investment in a firm unless the founders also have a personal
stake in the business.

• Initial non-founder financing usually comes first from private equity

investors
Issuing Common Stock: Venture Capital

Venture Capital
• is privately raised external equity capital used to fund early-
stage firms with attractive growth prospects.

Venture capitalists (VCs)

• are providers of venture capital; typically, formal businesses
that maintain strong oversight over the firms they invest in and
that have clearly defined exit strategies.
Issuing Common Stock: Venture Capital

Angel capitalists (angels)

• are wealthy individual investors who do not operate as a
business but invest in promising early-stage companies in
exchange for a portion of the firm's equity.
Organization of Venture Capital Investors
Organization Description
Small business investment Corporations chartered by the federal government that can borrow
companies (SBICs) at attractive rates from the US . Treasury and use the funds to make
venture capital investments in private companies.
Financial VC funds Subsidiaries of financial institutions, particularly banks, set up to
help young firms grow and, it I hoped, become major customers of
the institution.
Corporate VC funds Firms, sometimes subsidiaries, established by nonfinancial firms,
typically to gain access to new technologies that the corporation can
access to further its own growth.
VC limited partnerships Limited partnerships organized by professional VC firms, which
serve as the general partner and organize, invest, and manage the
partnership using the limited partners funds, the professional VC
ultimately a date the partnership and distribute the proceeds to all
partners.
Venture Capital: Deal Structure and Pricing
• To control the VC's risk, various covenants are included in
agreements and the actual funding provided may be staggered
based on the achievement of measurable milestones.

• The contract will also have a defined exit strategy.

• The amount of equity to which the VC is entitled depends on the

value of the firm, the terms of the contract, the exit terms, and
minimum compound annual rate of return required by the VC on
its investment
Going Public
When a firm wishes to sell its stock in the primary
market, it has three alternatives:

(1) a public offering

(2) a rights offering

(3) a private placement

Initial Public Offering (IPO)
• The first public sale of a firm’s stock.

Prospectus
• A portion of a security registration statement that describes the
key aspects of the issue, the issuer, and its management and
financial position.

Red Herring
• A preliminary prospectus made available to prospective investors
during the waiting period between the registration statement’s
filing with the SEC and its approval.
Investment Banker
• Financial intermediary that specializes in selling new security
issues and advising firms with regard to major financial
transactions.

Underwriting
• The role of the investment banker in bearing the risk of reselling,
at a profit, the securities purchased from an issuing corporation at
an agreed-on price.
Underwriting Syndicate
• A group of other bankers formed by an investment banker to
share the financial risk associated with underwriting new
securities.

Selling Group
• A large number of brokerage firms that join the originating
investment banker(s); each accepts responsibility for selling a
certain portion of a new security issue on a commission basis.
Selling Process for a Large Security Issues
$24

$26

$25.25

$26
Selling Process for a Large Security Issues

Compensation for underwriting and selling services

typically comes in the form of a discount on the sale
price of the securities.
COMMON STOCK VALUATION

• Common stockholders expect to be rewarded through

periodic cash dividends and an increasing share value.

• Some of these investors decide which stocks to buy and

sell based on a plan to maintain a broadly diversified
portfolio.
COMMON STOCK VALUATION

Other investors have a more speculative motive for trading.

• They try to spot companies whose shares are undervalued

• These investors buy shares that they believe to be undervalued
and sell shares that they think are overvalued
MARKET EFFICIENCY

• Rational buyers and sellers use their assessment of an asset’s

risk and return to determine its value.

• In competitive markets with many active participants, such as a

stock exchange, the interactions of many buyers and sellers result
in an equilibrium price—the market value—for each security.
Efficient-Market Hypothesis (EMH)
Theory describing the behavior of an assumed “perfect” market in
which

(1) securities are in equilibrium,

(2) security prices fully reflect all available information and react
swiftly to new information, and

(3), because stocks are fully and fairly priced, investors need not
waste time looking for mispriced securities.
The Behavioral Finance Challenge

Behavioral Finance
• a growing body of research that focuses on investor behavior and
its impact on investment decisions and stock prices. Advocates
are commonly referred to as “behaviorists.”

• We will use the terms expected return and required return

interchangeably because they should be equal in an efficient
market.
Understanding Human Behavior Helps Us Understand
Investor Behavior

• Regret theory deals with the emotional reaction people

experience after realizing they have made an error in judgment

• Some investors rationalize their decision to buy certain stocks

with "everyone else is doing it." (Herding)

• People have a tendency to place particular events into mental

compartments, and the difference between these compartments
sometimes impacts behavior more than the events themselves.
Understanding Human Behavior Helps Us Understand
Investor Behavior

• Prospect theory suggests that people express a different degree

of emotion toward gains than losses

• Anchoring is the tendency of investors to place more value on

recent information
Common Stock Valuation: Basic Common Stock
Valuation Equation
Common Stock Valuation: The Zero Growth Model
 Example
• CS estimates that the dividend of XYZ Company,
an established garment producer, is expected to
remain constant at $3 per share indefinitely.

Po= = = $20
Common Stock Valuation: Constant - Growth
Model
Common Stock Valuation: Constant - Growth
Model (Cont.)
2012 2011 2010 2009 2008 2007

1 2 3 4 5

-1
= ( -1
= 6.96% OR 7%
Common Stock Valuation:Constant - Growth
Model (Cont.)
Using a financial calculator, we find that the historical annual
growth rate of Lamar Company dividends equals
approximately 7%. The company estimates that its dividend
in 2013, D₁, will equal $1.50. The required return is 15%.
𝐷 2012 𝑥 (1+ 𝑔)1
𝑃𝑜=
𝑟𝑠− 𝑔
1
$ 1 . 40 𝑥(1 . 07)
¿
0 . 15 − 0 . 07
Common Stock Valuation:Variable - Growth
Model
Common Stock Valuation: Variable - Growth
Model (Cont.)
Common Stock Valuation:Variable - Growth
Model (Cont.)
Common Stock Valuation:Variable - Growth
Model (Cont.)
Common Stock Valuation: Variable - Growth
Model (Cont.)
Common Stock Valuation: Variable - Growth
Model (Cont.)
Calculation Present Value of Warren
Industries Dividends (2013 -2015)
Common Stock Valuation: Variable - Growth
Model (Cont.)
Common Stock Valuation: Variable - Growth
Model (Cont.)
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Free Cash Flow Valuation Model
 Free Cash Flow or FCF is an alternative to the dividend
valuations models, firm’s value can be estimated by using
this model.
 This approach is appeling when one is valuing firms that
have no divedend history.
 FCF is represent the forecast amount of cash flow in the
end of year to infinity or the cash flow value of entire
company.
Free Cash Flow (formula)
where:

• = free cash flow expected at the end of year (t)

• = the firms weighted average cost of capital
• = growth rate of FCF beyond 2020 to infinity
Free Cash Flow : Dewhurst Inc.
Free Cash Flow = 0.09 and = 0.03

Year (t) (FCFt)

2016 ＄ 400,000
2017 450,000
2018 520,000
2019 560,000
2020 600,000
Free Cash Flow : STEP ONE
Dewhurst Inc.

=$10,300,000
Free Cash Flow : STEP TWO
Dewhurst Inc.

FCF from 2021 infinity =10,300,000

2020 FCF value + 600,000
Total FCF in 2020 10,900,000
Free Cash Flow : STEP THREE
Dewhurst Inc.
Present value of FCFt

FCFt (1 + ra)t [(1) / (2)]

Year (t) (1) (2) (3)

2016 ＄ 400,000 1.090 ＄ 366,972

2017 450,000 1.188 378,788

2018 520,000 1.295 401,544

2019 560,000 1.412 396,601

2020 10,900,000 1.539 7,082,521

Value of entire company, Vc = $ 8,626,426

Free Cash Flow : STEP FOUR
Dewhurst Inc.
where:
VS = VC - VD - VP
• VS - Value of Common Stock
• VC - Value of entire Company
• VD - Value of all Debt
• VP - Value of Preferred Stock
Free Cash Flow : STEP FOUR
Dewhurst Inc.
where: Problem
VS = VC - VD - VP
• VS - ?
• VC - $8,626,426
• VD - $3,100,000
• VP - $800,000
*Other Detail: Number of shares of common stock
outstanding is 300,000.
Free Cash Flow : STEP FOUR
Dewhurst Inc.

Answer:
VS = $8,626,426 - $3,100,000 - $800,000
=$4,726,426
Free Cash Flow : STEP FOUR
Dewhurst Inc.
Answer:
Common Stock Value per Share
Common Stock / Number of Shares
= Common Stock Value per Share

= $4,726,426 / 300,000
= $15.75
Book Value Approach
• is a simply amount per share of common stock that would
be received if all the firm’s assets were sold for their exact
book (accounting) value.

• the proceeds remaining after paying all liabilities

(including preferred stock) were divided among the
common stockholders.
Book Value per Share
Lamar Company
where:
Total Assets - Total Liabilities
Shares of Common Stock
= Book Value per Share
TA = $6,000,000
TL = $4,500,000
Shares CS = 100,000 shares
Book Value per Share
Lamar Company

where:
$6,000,000 - $4,500,000
100,000 shares
= $15 per Share
Liquidation Value Approach
• Liquidation Value per share is the actual amount per
share of common stock when the firms’s assets were sold
for the market value.

• liabilities and preferred stock were paid, and any

remaining money were divided among the common
stock.
Liquidity Value per Share
Lamar Company
where:
Total Assets - Total Liabilities
Shares of Common Stock
= Liquidity Value per Share
TA (If it sold today)= $5,250,000
TL = $4,500,000
Shares CS = 100,000 shares
Liquidity Value per Share
Lamar Company

$5,250,000 - $4,500,000
100,000 shares
= $7.5 per Share
Price/Earnings Multiples Approach
• is a popular technique used to estimate the firm’s share
value.
• it is a simple method of determining the stock value after
the firms make earnings announcements.
Price/Earnings Multiples Approach
Lamar Company
where:

Earning Per Share x Average Price/Earnings

EPS = $2.60
PE = 7
Price/Earnings Multiples Approach
Lamar Company
where:

$2.60 x 7 = $18.2
Decision Making and Common Stock
Value

• measurement of stock value at a point in time based on

expected return and risk.

• used to forecast the future market prices and profit from

price changes.
Decision Making and Common Stock
Value

Effect on
1. Expected Return
Decision Action measured by Expected Effect on Stock Value
Dividends and Expected
by Financial Dividend Growth
Manager 2. Risk measured by the
Required Return
Change in Expected Dividends

• annualized percentage rate of growth that a particular

stocks’s dividend undergoes over a period of time.

• many companies seek to increase the dividends paid to

their investor on a regular basis.
Change in Expected Dividends
Lamar Company
where:

Po = D1 .
rs - g
D1 = Expected Dividend
rs = Required Return
g = Expected Dividend Growth
Change in Expected Dividends
Lamar Company
where:

Po = 1.50 .
0.15 - 0.09
= $25
Change in Risk

• is the probability that a change program will not reach its

stated objective and goals.

• associated with change are influenced by the firm’s

prefernce for change and the rate of change in the
industry.
Change in Risk
Lamar Company
where:

rs = IP + RP

rs = Required Return
IP = Risk Free Rate
RP = Risk Premium
Change in Risk
Lamar Company
where:

rs = 9% + 7%
= 16%
rs = ?
IP = 9%
RP = 6%
Change in Risk
Lamar Company
where:

rs = 9% + 7% Po = 1.50 .
= 16% 0.16 - 0.07
= $16.67
Combined Effect

• a financial decision is rarely affects the dividends and risk

independently.
• mostly decisions affect both factor often in the same
directon.
• firms take on more risk, their shareholders expect to see
higher dividends.
Combined Effect
Lamar Company
where:
Po = D1 .
rs - g
D1 = Expected Dividend
rs = Required Return
g = Expected Dividend Growth
Combined Effect
Lamar Company
where:
Po = 1.50 .
0.16 - 0.09
D1 = Expected Dividend
rs = Required Return
g = Expected Dividend Growth
Combined Effect
Lamar Company
where:
Po = 1.50 .
0.16 - 0.09
=21.43
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