# Chapter 9 Stocks and their valuation cacho mildred

**Topics:**Philippine Stock Exchange, Stock market, Stock exchange

**Pages:**35 (1974 words)

**Published:**June 7, 2015

Stocks and Their

Valuation

GME – 605

FINANCIAL

MANAGEMENT

Presented to:

Prof. Violeta Josef

Presented by:

Mildred F. Cacho

1

Learning Objectives:

Discuss the types of stocks.

Explain the distinction between a stock’s price and

its intrinsic value.

Identify the two models that can be used to estimate

a stock’s intrinsic value

List the key characteristics of preferred stock and

explain how to estimate the value of preferred stock.

9-2

STOCKS :

A type of security that signifies

ownership in a corporation and

represents a claim on part of the

corporation's assets and earnings.

9-3

Types of Stocks:

1. Common stock –

basic form of ownership of a corporation

have the right to vote at annual meetings, with each

share entitling the holder to one vote.

2. Preferred Stock

generally does not have voting rights, but has a

higher claim on assets and earnings than the

common shares.

9-4

Types of Common Stocks

1. Classified

Common stock that is given a special designation such

as Class A or Class B to meet special needs of the

company.

sold Class A stock to the public while its Class B stock was retained by the company’s insiders.

2. Founders’ Shares

Stock owned by the firm’s founders that has sole voting

rights but restricted dividends for a specified number of

years.

9-5

Stock price versus Intrinsic

Values

Stock price - simply the current market price, and it is

easily observed for publicly traded companies.

Intrinsic value - represents the “true” value of the

company’s stock, cannot be directly observed and must

instead be estimate

9-6

Different Approaches for

Estimating the Intrinsic Value

of a Common Stock

A. Discounted dividend model

zero-growth

constant-growth model

variable-growth

B.Corporate valuation model

9-7

A. Discounted Dividend Model

Value of a stock is the present value of the future dividends expected to be generated by the stock.

ˆ0

P

D3

D1

D2

D

...

1

2

3

(1 rs )

(1 rs )

(1 rs )

(1 rs )

9-8

A.1. Zero growth rate model

The zero-growth model assumes that

the dividend always stays the

same,thus,the stock price would be

equal to the annual dividends divided

by the required rate of return.

Stock’s Intrinsic Value = Annual

Dividends / Required Rate of Return

9-9

What would the expected price today

be, if g = 0?

0

rs = 13%

1

2

3

2.00

2.00

2.00

PMT $2.00

ˆ

P0

$15.38

r

0.13

9-10

A.2. Constant Growth Stock

(Gordon Growth Model)

11

Use the SML to Calculate the Required

Rate of Return (rs)

If rRF = 7%, rM = 12%, and b = 1.2,

what is the required rate of return

on the firm’s stock?

rs = rRF + (rM – rRF)b

= 7% + (12% – 7%)1.2

= 13%

9-12

Find the Expected Dividend Stream for the

Next 3 Years and Their PVs

D0 = $2 and g is a constant

6%.

0

g = 6%

D0 = 2.00

1

2

2.12

2.247

3

2.382

1.8761

1.7599

rs = 13%

1.6509

9-13

What is the stock’s

intrinsic value?

Using the constant growth model:

D1

$2.12

ˆ

P0

rs g 0.13 0.06

$2.12

0.07

$30.29

9-14

Find Expected Dividend Yield, Capital Gains Yield,

and Total Return During First Year

Dividend yield

= D1/P0 = $2.12/$30.29 = 7.0%

Capital gains yield

= (P1 – P0)/P0

= ($32.10 – $30.29)/$30.29 = 6.0%

Total return (rs)

= Dividend yield + Capital gains yield

= 7.0% + 6.0% = 13.0%

9-15

What is the expected market price of the

stock, one year from now?

D2

$2.247

ˆ

P1

rs g 0.13 0.06

$32.10

9-16

A.3 Valuing Common Stock with

Nonconstant Growth

(variable growth/supernatural

growth)

- security that experiences

particularly robust growth over an

extended period of time.

- is one that significantly

outperforms the market and

provides investors with returns that

are well above average.

9-17

0 r = 13%

s

1

2...

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