BMM Ch5 Valuing Stocks
Transcript of BMM Ch5 Valuing Stocks
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Chapter 5Fundamentals of Corporate Finance
Third Edition
Valuing Stocks
Brealey Myers Marcus
slides by Matthew Will
Irwin/McGraw-Hill The McGraw-Hill Companies, Inc.,2001
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Topics Covered
Stocks and the Stock Market
Book Values, Liquidation Values and
Market Values
Valuing Common Stocks
Simplifying the Dividend Discount Model
Growth Stocks and Income Stocks
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Stocks & Stock Market
Primary Market - Place where the sale of new stock
first occurs.
Initial Public Offering (IPO) - First offering of stock
to the general public.Seasoned Issue - Sale of new shares by a firm that
has already been through an IPO
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Stocks & Stock Market
Common Stock - Ownership shares in a
publicly held corporation.
Secondary Market - market in which already
issued securities are traded by investors.
Dividend - Periodic cash distribution from the
firm to the shareholders.
P/E Ratio - Price per share divided by
earnings per share.
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Stocks & Stock Market
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Trading
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NYSE
Nasdaq
London
Paris
Tokyo
German
Taiwan
Zurich
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Toronto
Amex
Stock Market
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Stocks & Stock Market
Book Value - Net worth of the firm according
to the balance sheet.
Liquidation Value - Net proceeds that would
be realized by selling the firms assets and
paying off its creditors.
Market Value Balance Sheet - Financial
statement that uses market value of assets
and liabilities.
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Valuing Common Stocks
Expected Return- The percentage yield that aninvestor forecasts from a specific investment over
a set period of time. Sometimes called the holding
period return (HPR).
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Valuing Common Stocks
Expected Return- The percentage yield that aninvestor forecasts from a specific investment over
a set period of time. Sometimes called the holding
period return (HPR).
Expected Return
rDiv P P
P
1 1 0
0
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Valuing Common Stocks
The formula can be broken into two parts.
Dividend Yield + Capital Appreciation
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Valuing Common Stocks
The formula can be broken into two parts.
Dividend Yield + Capital Appreciation
Expected Return
rDiv
P
P P
P1
0
1 0
0
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Valuing Common Stocks
Dividend Discount Model - Computation of todays
stock price which states that share value equals the
present value of all expected future dividends.
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Valuing Common Stocks
Dividend Discount Model - Computation of todays
stock price which states that share value equals the
present value of all expected future dividends.
H - Time horizon for your investment.
PDiv
r
Div
r
Div P
r
H H
H01
1
2
21 1 1
( ) ( )...
( )
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Valuing Common Stocks
Example
Current forecasts are for XYZ Company to pay
dividends of $3, $3.24, and $3.50 over the next
three years, respectively. At the end of three yearsyou anticipate selling your stock at a market price
of $94.48. What is the price of the stock given a
12% expected return?
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Valuing Common Stocks
Example
Current forecasts are for XYZ Company to pay dividends of $3, $3.24,
and $3.50 over the next three years, respectively. At the end of three
years you anticipate selling your stock at a market price of $94.48.
What is the price of the stock given a 12% expected return?
PV
PV
3 00
1 12
3 24
1 12
350 94 48
1 1200
1 2 3
.
( . )
.
( . )
. .
( . )$75.
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Valuing Common Stocks
If we forecast no growth, and plan to hold out
stock indefinitely, we will then value the stock as
a PERPETUITY.
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Valuing Common Stocks
If we forecast no growth, and plan to hold out
stock indefinitely, we will then value the stock as
a PERPETUITY.
Perpetuity PDiv
ror
EPS
r 0
1 1
Assumes all earnings are
paid to shareholders.
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Valuing Common Stocks
Constant Growth DDM - A version of the dividend
growth model in which dividends grow at a
constant rate (Gordon Growth Model).
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Valuing Common Stocks
Constant Growth DDM - A version of the dividend
growth model in which dividends grow at a
constant rate (Gordon Growth Model).
Given any combination of variables in theequation, you can solve for the unknown variable.
PDiv
r g0
1
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Valuing Common Stocks
Example
What is the value of a stock that expects to pay a
$3.00 dividend next year, and then increase the
dividend at a rate of 8% per year, indefinitely?Assume a 12% expected return.
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Valuing Common Stocks
Example
What is the value of a stock that expects to pay a
$3.00 dividend next year, and then increase the
dividend at a rate of 8% per year, indefinitely?Assume a 12% expected return.
P Divr g
01 00
12 0800
$3.. .
$75.
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Valuing Common Stocks
Example- continued
If the same stock is selling for $100 in the stock
market, what might the market be assuming about
the growth in dividends?
$100$3.
..
00
1209
gg
Answer
The market isassuming the dividend
will grow at 9% per
year, indefinitely.
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Valuing Common Stocks
If a firm elects to pay a lower dividend, and
reinvest the funds, the stock price may increase
because future dividends may be higher.
Payout Ratio - Fraction of earnings paid out as
dividends
Plowback Ratio - Fraction of earnings retained by
the firm.
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Valuing Common Stocks
Growth can be derived from applying the
return on equity to the percentage of
earnings plowed back into operations.
g = return on equity X plowback ratio
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Valuing Common Stocks
Example
Our company forecasts to pay a $5.00
dividend next year, which represents
100% of its earnings. This willprovide investors with a 12% expected
return. Instead, we decide to plow
back 40% of the earnings at the firms
current return on equity of 20%.What is the value of the stock before
and after the plowback decision?
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Valuing Common Stocks
Example
Our company forecasts to pay a $5.00 dividend next year, which
represents 100% of its earnings. This will provide investors with a
12% expected return. Instead, we decide to blow back 40% of the
earnings at the firms current return on equity of 20%. What is the
value of the stock before and after the plowback decision?
P05
12 67
. $41.
No Growth With Growth
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Valuing Common Stocks
Example
Our company forecasts to pay a $5.00 dividend next year, which
represents 100% of its earnings. This will provide investors with a
12% expected return. Instead, we decide to blow back 40% of the
earnings at the firms current return on equity of 20%. What is the
value of the stock before and after the plowback decision?
P05
12 67
. $41.
No Growth With Growth
g
P
. . .
. .$75.
20 40 083
12 08000
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Valuing Common Stocks
Example - continued
If the company did not plowback some earnings,
the stock price would remain at $41.67. With the
plowback, the price rose to $75.00.
The difference between these two numbers (75.00-
41.67=33.33) is called the Present Value of
Growth Opportunities (PVGO).
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Valuing Common Stocks
Present Value of Growth Opportunities
(PVGO) -Net present value of a firms
future investments.
Sustainable Growth Rate - Steady rate at
which a firm can grow: plowback ratio X
return on equity.
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Web Resources
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