brigham ch9 stock edited 97 2003

8/9/2019 Brigham Ch9 Stock Edited 97 2003

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Copyright 2002 by Harcourt, Inc. All rights reserved.

Stocks and Their aluation!"e#$ %righa&, '.(., and ).(. Houston. 200*. (unda&entals o#(inancial +anage&ent, th 'd, Harcourt College -ublishers, Ch.

(eatures o# co&&on stock

/eter&ining co&&on stock values

'##icient &arkets

-re#erred stock


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"epresents onership.

1nership i&plies control.

Stockholders elect directors.

/irectors elect &anage&ent.+anage&ents goal$ +a3i&i4e the

stock price.

(acts about Co&&on Stock


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Social5'thical 6uestion

Should &anage&ent be e7uallyconcerned about e&ployees,

custo&ers, suppliers, and 8thepublic,9 or :ust the stockholders;

In an enterprise econo&y,

&anage&ent should ork #orstockholders sub:ect to constraints!environ&ental, #air hiring, etc. andco&petition.


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A #ir& 8goes public9throughan I-1 hen the stock is #irsto##ered to the public.


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Issuer -roceeds #ro& sale

AT=T .0? billion

In#ineon Technologies >2.@2 billion

+etropolitan i#e Ins. Co. >2.B0 billion

TyCo& >2. billion

Denuity >*.* billion

%iggest I-1s o# 2000 in the ESA


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Average Initial "eturns on I-1s in

arious Countries

+alaysia

*00F

@BF

B0F

2BF

%ra4il

-ortu

gal

)apa

n

S0ed

en

Enite

d

States

Cana

da


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*. /ividend groth &odel$

G Constant Droth !Dordon +odel

G Supernor&al !onGconstant Droth Stock

G 'rratic Droth Stock

2. (ree cash #lo &ethod

?. Esing the &ultiples o# co&parable#ir&s

/i##erent Approaches #or aluing

Co&&on Stock


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/e#initions o# Ter&s

/t /ividend the stockholder e3pects toreceive at the end o# Jear t. /0is the&ost recent dividend, hich hasalready been paidK /*is the #irstdividend e3pected, and ill be paid atthe end o# this yearK /2is the dividend

e3pected at the end o# to years, andso #orth. /*represents the #irst cash#lo a ne purchaser o# the stock illreceive. ote that /0, the dividend thathas been paid, is knon ith certainty.

%ut all #uture dividends are e3pectedvalues, so the esti&ate o# /t&ay di##era&ong investors.

-0 Actual &arket price o# the stock today


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-0 '3pected price o# the stock at the end o#Jear t !pronounced 8- hat t9. -0is theintrinsic, or theoretical, value o# the stocktoday as seen by the particular investordoing the analysisK -*is the price

e3pected at the end o# one yearK and so on.ote that -0is the intrinsic value o# the stocktoday based on a particular investors

esti&ate o# the stocks e3pected dividendstrea& and the riskiness o# that strea&.Hence, hereas the &arket price -0is#i3ed and is identical #or all investors, -0could di##er a&ong investors depending on

ho opti&istic they are about theco&pany. The caret, or 8hat9 is used toindicate that -tis an esti&ated value.

contL


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contL

-0, the individual investors esti&ate o# the

intrinsic value today, could be above orbelo -0, the current stock price, but aninvestor ould buy the stock only i#his5her esti&ate o# -0ere e7ual orgreater than -0. Since they are &any

investors in the &arket, there can be &anyvalues #or -0. Hoever, e can think o# an8average9 or 8&arginal9 investors hoseactions actually deter&ine the &arketprice. (or these &arginal investors, -0

&ust -0K otherise a dise7uilibriu&ould e3ist, and buying and selling in the&arket ould change -0, until -0 -0#orthe &arginal investor.


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+arket -rice, -0 the price at hichthe stock sell in the &arket

Intrinsic alue, -0 the value o# anasset that, in the &ind o# a particularinvestor, is :usti#ied by the #actsK -0&ay be di##erent #ro& the assetscurrent &arket price.

Droth "ate, g The e3pected rate o#groth in dividends per share.


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g e3pected groth rate in dividendsas predicted by a &arginal investor.I# dividends are e3pected to gro ata constant rate, g is also e7ual to thee3pected rate o# groth in earnings

and in the stocks price. /i##erentinvestors &ay use di##erent gs toevaluate a #ir&s stock, but the&arket price, -0, is set on the basis

o# the g esti&ated by &arginalinvestors.


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"e7uired "ate o# "eturn, ks The

&ini&u& rate o# return on a co&&onstock that a stockholder considersacceptable.

ks &ini&u& acceptable, or re7uired,

rate o# return on the stock,considering both its riskiness andthe returns available on otherinvest&ents. Again, this ter&

generally relates to &arginalinvestors. The deter&inants o# ksinclude the real rate o# return,e3pected in#lation, and risk.


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'3pected "ate o# "eturn, ks The rateo# return on a co&&on stock that astockholder e3pects to receive in the#uture.

ks '3pected rate o# return that aninvestor ho buys the stock e3pectsto receive in the #uture. Ms!pronounced 8k hat s9 could be

above or belo ks, but one ouldbuy the stock only i# ksere e7ual orgreater than ks.


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Actual, "eali4ed "ate o# "eturn, ks The rate

o# return on a co&&on stock actuallyreceived by stockholders in so&e pastperiod. Ms &ay be greater, or less than,and5or ks.

ks actual, or reali4ed, after-the factrate o#return !pronounce 8k bar s9. Jou &aye3pect to obtain a return o# ks *BF i# youbuy '33on today, but i# the &arket goes

don, you &ay end up ne3t year ith anactual reali4ed return that is &uch loer,perhaps even negative.


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Capital Dains Jield The capital gainduring a given year divided by thebeginning price.

!-*G-05-0 '3pected capital gainsyield on the stock during the co&ingyear. I# the stock sells #or >*0 today,and i# it is e3pected to rise to >*0.B0at the end o# one year, the e3pectedcapital gain is -*G -0 >0.B0.'3pected capital gain yield >0.B05>*0 BF


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'3pected Total "eturn The su& o#the dividend yield and the e3pectedcapital gains yield.

'3pected total return ks '3pecteddividend yield !/*5-0 N e3pectedcapital gains yield !-*G-05-0. In our

e3a&ple, the e3pected total return is*0F N BF *BF


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( ) ( ) ( ) ( )-

/

k

/

k

/

k

/

ks s s s0

**

22

??

* * * *=

+

+

+

+

+

+ +

+

. . .

A stock hose dividends are e3pected togro #orever at a constant rate, g.

Stock alue - o# /ividends


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(or a Constant Droth Stock

/* /0!* N g*

/2

/0

!* N g2 /*

!*Ng*

/t /0!* N gt

-0

I# g is constant, then$

/0!* N g

ksO g

/*ksO g

P


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t

$t g1%%

tt

t&1

%'(%

)'&,*g+f$

t$ '(%'

>

0.2B

Jears !t0


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Assu&e beta *.2, k"( @F, and k+

*2F.


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/0as >2.00 and g is a constant UF.

(ind the e3pected dividends #or thene3t ? years, and their -s !ks *?F

0 *

2.2V@

2

2.?2

?g UF

>*.@U*

>*.@B

/0 2.00

>*.UB0

*?F2.*2


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2.*2

>2.*2

0.0@>?0.2


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/*ill have been paid, so e3pecteddividends are /2,/?, /Vand so on.

?0.2, /2/*!*Ng>2.*2!*.0U>2.2V@K

Could also #ind -*as #ollos$

ksO g 0.*? O 0.0U-*

2.2V@P

>?2.*0

-* -0!*.0U?0.2!*.0U>?2.*0


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(ind the e3pected dividend yield,capital gains yield, and total return

during the #irst year.

/ividend yld

Cap gains yld

Total return @.0F N U.0F *?.0F

/*

-0-*O-0

-0

P>?0.2

>2.*2

@.0F

>?2.*0O>?0.2>?0.2

U.0F


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"earrange &odel to rate o# return #or&$

-

/

k g

/

- gs0* *

0

=

= +

to k s

Then, ks >2.*25>?0.2 N 0.0U 0.0@ N 0.0U *?F

P


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-0 >*B.?

2.00

0.*?

P


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Can no longer use constant groth&odel.

Hoever, groth beco&es constanta#ter ? years.

I# e have supernor&al groth o# ?0F#or ? years, then a longGrun constant

g UF, hat is -0; ksis still *?F.P


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aluing a Supernor&al5onGconstantDroth Stock

Supernor&al5nonGconstant groth is that

part o# the #ir&s li#e cycle in hich it gros

#aster than the econo&y as a hole.

Steps to alue Supernor&al Droth Stock$

*. Co&pute the e3pected #uture cash

dividendscontL.

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2. Co&pute the stocks price at a

#uture point in ti&e, using constantgroth &odel -t /tN*5!rGg. !Jou&ust pick a point a#ter the dividendgroth rate has beco&e constant

?. Co&pute the - o# the e3pected#uture sale price and add that to the- o# all the e3pected cashdividends beteen no and then.

(Source: Emery, D.R., J.D. Finnerty andJ.D. Stowe.1998. rinci!le" of Financial#ana$ement. rentice %all, !! 1&'-1&)

9 34


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onconstant groth #olloed by

constant groth$0

2.?0*

2.UV@

?.0VB

VU.**V

* 2 ? Vks *?F

BV.*0@ -0

g ?0F g ?0F g ?0F g UF...

/0 2.00 2.U00 ?.?0 V.?V V.UB

.

. .>UU.BV-?

V.UB

*? 0 0U0

...

P

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2.U0>BV.**

9 36


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/uring nonconstant groth,dividend yield !/5- and capitalgains yield are not constant, and

capital gains yield is not e7ual to g.A#ter t ?, g constant UF

capital gains yieldK ks *?FK so /5-

*?FUF @F.

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2B.@2

Suppose g 0F #or t * to ?, and theng is a constant UF.


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I# g GUF, ould anyone buy the

stock; I# so, at hat price;

(ir& still has earnings and still pays

dividends, so -0Q 0$( )

-/

k g

/ g

k gs s0

* 0 *

+

>2.00!0.V >*.

0.*? O !G0.0U 0.* >..

O O

N

9 41


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(urther '3a&ple o# Supernor&al DrothStock

etscape is operating in a ne industry that hasrecently caught on ith the public. Sales aregroing at 0F per year. This high sales groth is

e3pected to translate into a 2BF groth rate in cashdividends #or each o# the ne3t V years. A#ter that, thedividend groth rate is e3pected to be BF #orever.Annual dividend paid yesterday is >0.@B. The stocksre7uired return is 22F.


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i Co&pute the e3pected #uture cash dividends$

Ti&e 0 * 2 ? V B U ... /iv!> 0.@B 0.? *.*@2 *.VUB *.?* *.2? 2.0* L

g!F 2BF 2BF 2BF 2BF BF BF BF L

ii (ind the stock price at a #uture ti&e, a point a#ter hich the dividend groth rate has

beco&e constant #orever. That point is at year B, thus$

-B /U5!rGg >2.0*5!0.22G0.0B >**.@U

iii Co&pute the -s o# all the #uture e3pected cash dividends #ound in step !i

and add to the - o# the e3pected #uture sale price !-B calculated in step !ii$

-0 0.?5*.22*N *.*@25*.222 *.VUB5*.22?

N *.?*5*.22VN *.2?5*.22BN **.@U5*.22B

>!0.@U N 0.@@ N 0.0@ N 0.2@ N 0.@** N V.?V

>.2B


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'3a&ple$

ovells dividend as >* last year and is to be >* #or

each o# the ne3t ? years. A#ter its pro:ects have beendeveloped, earnings are e3pected to gro at a high rate#or 2 years as sales resulting #ro& ne pro:ects arereali4ed. The higher earnings are e3pected to result inV0F increase in dividends #or 2 years. A#ter these 2e3traordinary increases in dividends, the dividend

groth rate is e3pected to be ?F per year #orever.ovells re7uired rate o# return is *2F. *.00 *.00 *.00 *.00 *.V0 *.U 2.0* 2.0@ L

Droth 0F 0F 0F V0F V0F ?F ?F ?FL.

contL

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!ii /Bis here the groth rate in dividends is e3pected tobeco&e constant #orever and is the earliest point thatsatis#ies the constantGgroth assu&ption. *.U,

g?F, and r *2F,

-0/*5! *Nr* N /25!*Nr2NL/n5!*NrnN !*Ng/n5W!*Nrn!rGgZ

-0 *.005*.*2*

N *.005*.*22

N *.005*.*2?

N*.V05*.*2V

N *.U5*.*2B

N !*N0.0?*.U5W!*.*2B!0.*2G0.0?Z

>*@.*?

9 46


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(ree Cash (lo +ethod5Total Co&pany orCorporate aluation +odel

The #ree cash #lo &ethod suggeststhat the value o# the entire #ir&e7uals the present value o# the #ir&s

#ree cash #los !calculated on ana#terGta3 basis.

"ecall that the #ree cash #lo in any

given year can be calculated as$1-AT O et capital invest&ent

!1-AT et operating pro#it a#ter ta3es

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The Corporate aluation +odel !Te3t,pg ?0U

+arket alueco&pany - o# e3pected #uture (reecash #los o# co&pany

(C(*5!*Nr* N(C(25!*Nr2NL(C(n5!*Nrn

(C( !'%IT!*GT N /ep N A&ort G !Cap '3p N Change in 1


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1nce the value o# the #ir& is esti&ated,an esti&ate o# the stock price can be

#ound as #ollos$+ o# co&&on stock !&arket

capitali4ation + o# #ir& O + o#

debt and pre#erred stock.- + o# co&&on stock5[ o# shares.

Esing the (ree Cash (lo +ethod

P

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(ree cash #lo &ethod is o#ten

pre#erred to the dividend groth&odel GG particularly #or the largenu&ber o# co&panies that dont paya dividend, or #or ho& it is hard to

#orecast dividends.

Issues "egarding the (ree Cash (lo

+ethod

Cont..

9 - 5$


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Si&ilar to the dividend groth &odel,the #ree cash #lo &ethod generally

assu&es that at so&e point in ti&e,the groth rate in #ree cash #lo illbeco&e constant.

Ter&inal value represents the value o#the #ir& at the point in hich grothbeco&es constant.

(C( +ethod Issues !continued

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>V*U.V2

(C( esti&ates #or the ne3t ? years areG>B, >*0, and >20 &illion, a#ter hich the (C( ise3pected to gro at UF. The overall #ir& cost o#

capital is *0F.

!rGg 0.*0G0.0U 0.0V

0

GV.BVB.2UV

*B.02U?.*@

* 2 ? Vk *0F

g UF

GB *0 20 2*.20

2*.200.0V

...

\T?represents the ter&inal value o#the #ir&, at t ?

>B?0 \T?

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I# the #ir& has >V0 &illion in debt andhas *0 &illion shares o# stock, hat is

the price per share;

alue o# e7uity Total value O alue o# debt

>V*U.VO>V0

>[email protected] &illion

-rice per share alue o# e7uity5[ o# shares >[email protected]*0

>[email protected]

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Analysts o#ten use the #olloing &ultiples tovalue stocks$

-5'-5C(-5Sales-5Custo&er

'3a&ple$ %ased on co&parable #ir&s,esti&ate the appropriate -5'. +ultiply this bye3pected earnings to back out an esti&ate o#the stock price.

Esing the +ultiples o# Co&parable

(ir&s to 'sti&ate Stock -rice

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'3pected returns are obtained by esti&atingdividends and e3pected capital gains !hichcan be #ound using any o# the threeco&&on stock valuation approaches.P

Ms !/*5-0 N g

"e7uired returns are obtained #ro& the

CA-+$ks k"(N !k+O k"(#ir&

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Ho is e7uilibriu& established;

I# ks N g Q ks!CA-+ then

-0is 8too lo9 !a bargain.

%uy orders Q sell ordersK

-0bid upK /*5-0#alls until

!/*5-0 N g ks ks

P

P

/*-0

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*.


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2. Se&istrongG#or& '+H$

All publicly availablein#or&ation is re#lected instock prices, so doesnt pay to

pore over annual reportslooking #or undervaluedstocks. argely true, but

superior analysts can stillpro#it by #inding and using nein#or&ation.

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?. StrongG#or& '+H$All in#or&ation, even insidein#or&ation, is e&bedded instock prices. ot trueGGinsiders

can gain by trading on the basiso# insider in#or&ation, but thatsillegal.

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*. *B,000 or so trained analystsK +%As,

C(As, Technical -h/s.2.


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-re#erred Stock

Hybrid security.

Si&ilar to bonds in that pre#erred

stockholders receive a #i3ed dividend that&ust be paid be#ore dividends can be paidon co&&on stock.

Hoever, unlike interest pay&ents on

bonds, co&panies can o&it dividendpay&ents on pre#erred stock ithout #earo# pushing the #ir& into bankruptcy.

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B0 and

annual dividend >B;

.kB>B0>p

p

F.0.*0*0.0B0>B>kS p

brigham ch9 stock edited 97 2003

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