Chapter 9 Stocks and their valuation cacho mildred

Topics: Philippine Stock Exchange, Stock market, Stock exchange Pages: 35 (1974 words) Published: June 7, 2015
CHAPTER 10:
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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