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Stock Valuation

Chapter 8

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter Outline

• Common Stock Valuation

• Features of Stocks

• Stock Market Reporting

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Common Stock Valuation

Estimating Dividends - 3 Special Cases:

1. Zero Growth

2. Constant Growth

3. Non-constant growth

The Comparables Approach

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1. Zero Growth

• If the same dividends are expected at regular intervals forever, then this is like preferred stock and is valued as a .

PV = C / RP = D / R

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Zero Growth Example

• A stock is expected to pay a $2 dividend forever and the market rate of return is 10%. What is the value of the stock?

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2. Constant Growth

• Dividends are expected to grow at a constant percent per period forever.

• Use the “Dividend Growth Model”:

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g-R

D

g-R

g)1(DP 100

Constant Growth Example:

• The current dividend of a stock is $5 and the expected growth rate is 3%. The market rate of return is 11%. What is the price of the stock today?

• What is the price in four years?

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3. Non-Constant Growth

• Non-constant growth really means: constant growth after period t.1. Compute the future price at the time (t) when the dividends grow at a constant rate forever, using the dividend growth model.2. Find the present value of the expected future cash flows (i.e. the irregular dividends and the future price at time t).

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Non-Constant Growth Example I

• The next three dividends for a company are expected to be $.50, $.75, and $1.50. Then the dividends are expected to grow at a constant 5% forever. If the required return for the company is 10%, what is the present value of the stock?

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Non-Constant Growth Example II

• The next dividend of a common stock is expected to be $0.70. The dividends will grow at 6% for the next two years and then grow at 4% forever. If the required return for the company is 8%, what is the present value of the stock?

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Common Stock Valuation: The “Comparables” Approach

1. Pick a “comparable” stock (similar g) and find its PE ratio.

2. Rearrange the PE formula to solve for the price per share.

PE = price per share/earnings per share

price per share = PE x earnings per share For example: you are trying to value the stock of a company.

The company has $2 in earnings per share. If a comparable firm (with a similar growth rate) has a PE ratio of 15, what is the value of the stock?

Price per share =

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Features of Stock• Voting Rights

1. cumulative voting:all directors are voted “at once”# of votes = # of shares owned x N

# of shares required to guarantee a seat = [ 1/(N+1) x # of shares outstanding] +1

where N = # of directors to be elected

2. straight voting:directors are voted “one at a time”# of votes = # of shares owned# of shares required to guarantee a seat =[ # of shares outstanding / 2] +1 12

Features of Stock Continued

• Voting Rights Example:Assume a company has 10,000 shares outstanding and 4 directors need to be elected in the next meeting. How many shares does it take to guarantee a seat on the board under cumulative and under straight voting?

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Features of Stock Continued

• Proxy voting• Classes of stock• Dividends

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Stock Market Reporting

52WEEKS YLD VOL NETHI LO STOCKSYMDIV % PE 100s HI LOCLOSE CHG

52.75 19.06 Gap Inc GPS 0.09 0.5 15 65172 20.50 19 19.25 -1.75

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