Stock Valuations

MBA (FinTech)Trimester-II

GITAM FinTech Academy

GITAM University

8th Nov 2018

Stock Valuations
Leben Johnson
Stock Markets

Legal Rights & Privileges

• Control of the firm
• Pre-emptive Right

Types of Stocks
• Ordinary / Common Shares
• Preferred Shares
• Class-A,B….
• Founders Shares
• Tracker / Target Stock

Stock Market Reporting

• Openbook
• Market depth
• Stock Quote

Stock Valuations
Leben Johnson
Common Stock Valuation

Dividend Discount Model as Basis of Valuations

Define

Value of the stock = PV of expected future dividends

=
PV of stock = D/k
where D is expected constant perpetual dividend
k is discount rate

Constant Growth Dividend Discount Model

PV of stock = D1/(k-g)
where D1 = Expected dividend per share expected next year
g = Rate at which dividend is expected to grow.

Stock Valuations
Leben Johnson
Common Stock Valuation
Expected Rate of Return on a Constant Growth Stock

Expected Rate of Return = Expected Dividend Yield + Expected growth rate or

Capital Gains Yield

ie R = D1 + G
P0

Stock Valuations
Leben Johnson
Common Stock Valuation
Price-Earnings (PE) Method

Forecasted earnings in n years = E(1 + G)n

Where E = Current Earnings

G = Expected growth rate of earnings

Stock price in n years = (Earnings in n years) * (PE ratio of Industry)

Stock Valuations
Leben Johnson
Common Stock Valuation
Free Cash Flow Approach

V = FCF(1 + g)_
(WACC – g)

Where FCF = Free cash flow available for distribution to all investors
WACC = Weighted Average Cost of Capital

Stock Valuations
Leben Johnson
Common Stock Valuation
Stock Market Equilibrium:

Capital Asset Pricing Model (CAPM): Assumes main risk as Systematic Risk

Return on Investment (Ri) = Risk-Free Return +

(Market Risk Premium) * Beta

ie Ri = Rrf + (RPm)bi

Market Risk Premium RPm = Rm – Rrf

Rm is the Market Return

ie Ri = Rrf + (Rm – Rrf)bi

Expected Rate of Return = Di + g

Po

Stock Valuations
Leben Johnson
Common Stock Valuation
Efficient Market Hypothesis:
Assumes 1) Stocks are always in equilibrium
2) It is impossible for an investor to consistently “beat the market”

Weak-Form Efficiency
Assumes 1) All information in the past price movements is fully reflected
in the current market price.
2) Chartists and tape-watchers are wasting their time.

Semistrong Form Efficiency

Assumes 1) Current market prices reflect all publicly available information.

Strong-Form Efficiency
Assumes 1) Current market prices reflect all public and private information.

Stock Valuations
Leben Johnson
Initial Public Offerings (IPO)
Start-Ups
• Self funding
• Angel Funding
• Venture Capital Funds
• Initial Public Offering

Advantages of IPO
• Increases liquidity and allows founders to harvest their wealth.
• Permits founders to diversify
• Facilitates raising new corporate cash
• Establishes a value for the firm
• Facilitates merger negotiations
• Increases potential markets

Disadvantages of IPO
• Cost of reporting
• Disclosure
• Self-dealings
• Inactive market/low price
• Control
•Investor Relations
Stock Valuations
Leben Johnson
Process of Going IPO
• Selecting an Investment Bank
• Underwriting Syndicate
• Regulation of Securities Sale
• Roadshow and Book-building
• First day of Trading
• The costs of going public
• The importance of the Secondary Market
• Regulating the Secondary Market
• Questionable IPO Practices

Stock Valuations
Leben Johnson
Depository Receipts
Negotiable certificates issues by banks to represent the underlying shares of
stock, which is held in a trust in a foreign custodial bank.

• Global Depository Receipts:

- Certificates traded outside the United States

• American Depository Receipts:

- Certificates traded in the United States and denominated in US$
- Each ADR = A multiple of the underlying foreign share

Stock Valuations
Leben Johnson