55
8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin

8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Embed Size (px)

Citation preview

Page 1: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-1

Stock Valuation

Chapter 8

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

Page 2: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-2

Chapter Outline

• Bond and Stock Differences• Common Stock Valuation• Features of Common Stock• Features of Preferred Stock• The Stock Markets

Page 3: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-3

Bonds and Stocks: Similarities• Both provide long-term

funding for the organization

• Both are future funds that an investor must consider

• Both have future periodic payments

• Both can be purchased in a marketplace at a price “today”

Page 4: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-4

Bonds and Stocks: Differences• From the firm’s perspective: a

bond is a long-term debt and stock is equity

• From the firm’s perspective: a bond gets paid off at the maturity date; stock continues indefinitely.

• We will discuss the mix of bonds (debt) and stock (equity) in a future chapter entitled capital structure

Page 5: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-5

Bonds and Stocks: Differences

• A bond has coupon payments and a lump-sum payment; stock has dividend payments forever

• Coupon payments are fixed; stock dividends change or “grow” over time

Page 6: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-6

A visual representation of a bond with a coupon payment (C) and a maturity value (M)

1 2 3 4 5

$C1 $C2 $C3 $C4 $C5

$M

Page 7: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-7

A visual representation of a share of common stock with dividends (D) forever1 2 3 4 5

$D1 $D2 $D3 $D4 $D5 $D∞

Page 8: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-8

Comparison Valuations

1 2 3Bond

C CCM

P0

0

1 2 3Common Stock

D1 D2 D3 D∞P0

0

Page 9: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-9

Notice these differences:• The “C’s” are constant and equal• The bond ends (year 5 here)• There is a lump sum at the end

1 2 3 4 5

$C1 $C2 $C3 $C4 $C5

$M

Page 10: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-10

Notice these differences:• The dividends are different• The stock never ends• There is no lump sum

1 2 3 4 5

$D1 $D2 $D3 $D4 $D5 $D∞

Page 11: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-11

Our Task:To value a share

of Common Stock

Page 12: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-12

BAEFEIPVT

BringAllExpectedFutureEarningsIntoPresentValueTerms

Page 13: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-13

BAEFEIPVTJust remember:

Page 14: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-14

Cash Flows for Stockholders

If you buy a share of stock, you can receive cash in two ways:

1. The company pays dividends

2. You sell your shares, either to another investor in the market or back to the company

Page 15: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-15

One-Period Example

Receiving one future dividend and one future selling price of a share of common stock

Page 16: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-16

One-Period Example

Suppose you are thinking of purchasing the stock of Moore Oil, Inc. You expect it to pay a $2 dividend in one year, and you believe that you can sell the stock for $14 at that time.

If you require a return of 20% on investments of this risk, what is the maximum you would be willing to pay?

Page 17: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-17

Visually this would look like:

1

D1 = $2

P1 = $14

R = 20%

Page 18: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-18

Compute the Present Value

1

D1 = $2

P1 = $14

R = 20%

$1.67

$11.67

PV =$13.34

Page 19: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

1 year = N

20% = Discount rate

$2 = Payment (PMT)

$14 = FV

PV = ?

-13.34

1st

2nd

TI BA II Plus

8-198-19

Page 20: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-20

$14 = FV

1 year = N

$2 = Payment (PMT)20% = Discount rate

PV = ?

-13.34

HP 12-C

Page 21: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-21

Two Period Example

Now, what if you decide to hold the stock for two years? In addition to the dividend in one year, you expect a dividend of $2.10 in two years and a stock price of $14.70 at the end of year. Now how much would you be willing to pay?

Page 22: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-22

Visually this would look like:

2

D1 = $2

P2 = $14.70

R = 20% 1

D2 = $ 2.10

Page 23: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-23

Compute the Present Value

2

D1 = $2

P2 = $14.70

R = 20% 1

D2 = $ 2.10$1.67$1.46

$ 10.21

$ 13.34 = P0

Page 24: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-24

What is the Observed Pattern?

We value a share of stock by bring back all expected future dividends into present value terms

Page 25: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-25

Future Dividends

So the key is to determine the future dividends when given the growth rate of those dividends, whether the growth is zero, constant, or unusual first and then levels off to a constant growth rate.

Page 26: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-26

So how do you compute the future

dividends?Three scenarios:

1.A constant dividend (zero growth)

2.The dividends change by a constant growth rate

3.We have some unusual growth periods and then level off to a constant growth rate

Page 27: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-27

1. Constant Dividend – Zero Growth• The firm will pay a

constant dividend forever

• This is like preferred stock

• The price is computed using the perpetuity formula:

P0 = D / R

Page 28: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-28

So how do you compute the future

dividends?Three scenarios:

1. A constant dividend (zero growth)

2. The dividends change by a constant growth rate

3. We have some unusual growth periods and then level off to a constant growth rate

Page 29: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-29

2. Constant Growth Rate of Dividends

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

P0 = D1 /(1+R) + D2 /(1+R)2 + D3 /(1+R)3 + …

P0 = D0(1+g)/(1+R) + D0(1+g)2/(1+R)2 + D0(1+g)3/(1+R)3 + …

Page 30: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-30

2. Constant Growth Rate of Dividends

With a little algebra this reduces to:

g-R

D

g-R

g)1(DP 10

0

Page 31: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-31

2. Constant Growth Rate of Dividends

Student caution:

g-R

D

g-R

g)1(DP 10

0

A. What happens if g > R?B. What happens if g = R?

Page 32: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-32

Dividend Growth Model (DGM) Assumptions

To use the Dividend Growth Model (aka the Gordon Model), you must meet all three requirements:

1.The growth of all future dividends must be constant,

2.The growth rate must be smaller than the discount rate ( g < R), and

3.The growth rate must not be equal to the discount rate (g ≠ R)

Page 33: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-33

DGM – Example 1

Suppose Big D, Inc., just paid a dividend (D0) of $0.50 per share. It is expected to increase its dividend by 2% per year.

If the market requires a return of 15% on assets of this risk, how much should the stock be selling for?

Page 34: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-34

DGM – Example 1 Solution

P0 = .50 ( 1 + .02) .15 - .02

g-R

D

g-R

g)1(DP 10

0

P0 = .51 .13

= $3.92

Page 35: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-35

DGM – Example 2

Suppose Moore Oil Inc., is expected to pay a $2 dividend in one year. If the dividend is expected to grow at 5% per year and the required return is 20%, what is the price?

Page 36: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-36

DGM – Example 2 Solution

P0 = 2.00 .20 - .05

g-R

D

g-R

g)1(DP 10

0

P0 = 2.00 .15

= $13.34

Page 37: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-37

So how do you compute the future

dividends?Three scenarios:

1.A constant dividend (zero growth)

2.The dividends change by a constant growth rate

3.We have some unusual growth periods and then level off to a constant growth rate

Page 38: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-38

Using the DGM to Find R

gP

D g

P

g)1(D R

g-R

D

g - R

g)1(DP

0

1

0

0

100

Start with the DGM and then algebraically rearrange the equation to solve for R:

Page 39: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-39

Finding the Required Return - Example

Suppose a firm’s stock is selling for $10.50. It just paid a $1 dividend, and dividends are expected to grow at 5% per year. What is the required return? R = [1(1.05)/10.50] + .05 = 15%What is the dividend yield?

1(1.05) / 10.50 = 10%What is the capital gains

yield?

g =5%

Page 40: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-40

Stock Valuation Alternative

But my company doesn’t pay dividends!

How can I value the stock?

Page 41: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-41

Valuation Using Multiples

We can use the PE ratio and/or the price-sales ratio:

Pt = Benchmark PE ratio X EPSt

Pt = Benchmark price-sales ratio X Sales per sharet

Page 42: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-42

Stock Valuation Summary

Page 43: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-43

Features of Common Stock

• Voting Rights• Proxy voting• Classes of stock

Page 44: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-44

Dividend Characteristics

• Dividends are not a liability of the firm until a dividend has been declared by the Board

• Consequently, a firm cannot go bankrupt for not declaring dividends

Page 45: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-45

Dividend Characteristics

Dividends and Taxes

• Dividend payments are not considered a business expense; therefore, they are not tax deductible

• The taxation of dividends received by individuals depends on the holding period

• Dividends received by corporations have a minimum 70% exclusion from taxable income

Page 46: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-46

Stock Market, Dealers vs. Brokers

Dealer: trades with inventory for bid and ask pricesBroker: matches buyers and sellers for a fee

Page 47: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-47

Stock Market• New York Stock Exchange

(NYSE)

• Largest stock market in the world

• License holders (1,366)• Commission brokers• Specialists• Floor brokers• Floor traders

• Operations

• Floor activity

Page 48: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-48

NASDAQ• Not a physical exchange – it is a

computer-based quotation system

• Multiple market makers

• Electronic Communications Networks

Page 49: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-49

NASDAQ• Three levels of information:• Level 1 – median quotes,

registered representatives

• Level 2 – view quotes, brokers & dealers

• Level 3 – view and update quotes, dealers only

• A large portion of technology stocks are bought and sold each day on NASDAQ

Page 50: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-50

Reading Stock Quotes

Page 51: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-51

Comprehensive Problem

XYZ stock currently sells for $50 per share. The next expected annual dividend is $2, and the growth rate is 6%. What is the expected rate of return on this stock?

If the required rate of return on this stock were 12%, what would the stock price be, and what would the dividend yield be?

Page 52: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-52

Formulas

gP

D g

P

g)1(D R

g-R

D

g - R

g)1(DP

0

1

0

0

100

P0 = D R

Value of a Perpetuity:

Value of a Share of Common Stock using the DGM:

Page 53: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-53

Formulas

Value of a Share of Common Stock using Multiples

Pt = Benchmark PE ratio X EPSt

Pt = Benchmark price-sales ratio X Sales per sharet

Page 54: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-54

1. A stock’s value is the present value of all expected future earnings.

2. Computing the future dividends of a stock is the key to understanding its value

3. Issuing stock provides the firm long-term funding

What are the most important topics of this chapter?

Page 55: 8-1 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

8-55

4. The Dividend Growth Model (DGM) provides us help with infinite dividend streams

5. Stocks are bought and sold each business day with reporting via stock quotes

What are the most important topics of this chapter?