Discussion 3
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Ch9-Stockvaluation.pptxChapter 9. Stock valuation
1
Overview
Features of Common Stock
Intrinsic Value and Stock Price
Determining Common Stock Values
Discounted Dividend Model
Other Approaches
Preferred Stock
2
Common Stockholders
Are the owners of the corporation
Have residual claims on the assets and proceeds of the firm
Have limited liability
Have the preemptive right, which grants existing shareholders the first right to purchase any new stock
Have the right to vote on major matters affecting the firm
Facts About Common Stock
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Outside investors, corporate insiders, and analysts use a variety of approaches to estimate a stock’s intrinsic value.
In equilibrium we assume that a stock’s price equals its intrinsic value.
Trading Signal
Intrinsic value > market price, Buy
Intrinsic value < market price, Sell or Short Sell
Intrinsic value = market price, Hold or Fairly Priced
Intrinsic Value and Stock Price
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Value of a stock is the present value of all the future dividends expected to be generated by the stock.
P0 = intrinsic value of stock
Dt = Dividend in period t (t=1,2,…)
r = required rate of return or discount rate
Discounted Dividend Model
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Assume that dividends will remain at the same level forever
So, PV of a perpetuity:
Case 1: Zero Growth
6
Example
Assume that you own one share of Reliant Energy. The stock is expected to pay constant annual dividends equaling $2 indefinitely, and the last dividend has just been paid. Given the discount rate of 10%, what is the price of stock today?
Case 1: Zero Growth
7
Case 2- Constant Growth
Assume that dividends will grow at a constant rate g
So, PV of a growing perpetuity:
8
Example
Utah Mining will pay a dividend of $3 per share one year from today. The dividend is expected to grow at 10% per year. Assume the discount rate for Utah Mining is 15%. What is the value of one share of Utah Mining common stock?
Case 2- Constant Growth
9
The constant growth dividend discount model is usually called the Gordon Dividend Discount Model after Myron Gordon who popularized it.
In this model, P0 grows to infinity as g approaches r.
P0 is not defined for g=r or g>r.
The Gordon Model
10
Case 3- Nonconstant Growth
What is the intrinsic value of the stock if g = 30% for 1 yr., 20% for 1 yr., and 10% for 1 yr. before achieving long-run growth of 4%? The required rate of return is 9%. D0=$2.00.
Can no longer use just the constant growth model to find stock value.
However, the growth does become constant after 3 years.
Case 3- Nonconstant Growth
r = 9%
g = 30%
g = 20%
g = 10%
g = 4%
2.385
2.626
2.650
55.123
62.784 =
0
1
2
3
4
2.600 3.120 3.432
3.5693
D0 = $2.00.
© 2020 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Case 3- Nonconstant Growth
r = 9%
g = 0%
g = 0%
g = 0%
g = 4%
1.84
1.68
1.55
32.12
37.19 =
0
1
2
3
4
2.00 2.00 2.00
2.08
D0 = $2.00.
What if g = 0% for 3 years before long-run growth of 4%?
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Exercise:
A common stock just paid a dividend of $2. The dividend is expected to grow at 8% for 3 years, then it will grow at 4% in perpetuity. What is the stock worth? The discount rate is 12%.
Case 3- Nonconstant Growth
14
…
0 1 2 3 4
0 1 2 3
The constant growth phase beginning in year 4 can be valued as a growing perpetuity at time 3.
Case 3- Nonconstant Growth
15
This type of problem generally separates the “A” students from the rest of the class.
Analysts often use the following multiples to value stocks.
P/E
P/CF
P/Sales
EXAMPLE: Based on comparable firms, estimate the appropriate P/E. Multiply this by expected earnings to back out an estimate of the stock price.
Enterprise-Based Multiples
EV/EBITDA
Firm Multiples Method
© 2020 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Are a hybrid of financing, combining features of debt and common stock
Occupies a middle position between bonds and common stocks both in terms of priority of payment of income and in case the firm is liquidated
Pay dividends, which are specified and known in advance.
Most preferred dividends are cumulative. If the firm omits a dividend, it must pay it later before any new dividends are paid.
Have no voting rights unless the company is unable to pay dividends during a specified period
Preferred stock
17
Preferred stock
If preferred stock with an annual dividend of $5 sells for $100, what is the preferred stock’s expected return?
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