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Chapter 13. Equity Valuation. Fundamental Stock Analysis: Models of Equity Valuation. Basic Types of Models Balance Sheet Models Dividend Discount Models Price/Earning Ratios Estimating Growth Rates and Opportunities. Intrinsic Value and Market Price. Intrinsic Value Self assigned Value - PowerPoint PPT Presentation
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Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus1
Chapter 13
Equity Valuation
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus2
Fundamental Stock Analysis: Models of Equity Valuation
• Basic Types of Models– Balance Sheet Models– Dividend Discount Models– Price/Earning Ratios
• Estimating Growth Rates and Opportunities
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus3
Intrinsic Value and Market Price
• Intrinsic Value– Self assigned Value– Variety of models are used for estimation
• Market Price– Consensus value of all potential traders
• Trading Signal– IV > MP Buy– IV < MP Sell or Short Sell– IV = MP Hold or Fairly Priced
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus4
Dividend Discount Models:General Model
VD
ko
t
tt
( )11
VD
ko
t
tt
( )11
• V0 = Value of Stock• Dt = Dividend• k = required return
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus5
No Growth Model
VD
ko
• Stocks that have earnings and dividends that are expected to remain constant
• Preferred Stock
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus6
No Growth Model: Example
E1 = D1 = $5.00
k = .15
V0 = $5.00 / .15 = $33.33
VD
ko
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus7
Constant Growth Model
VoD g
k g
o
( )1Vo
D g
k g
o
( )1
• g = constant perpetual growth rate
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus8
Constant Growth Model: Example
VoD g
k g
o
( )1Vo
D g
k g
o
( )1
E1 = $5.00b = 40% k = 15%
(1-b) = 60% D1 = $3.00 g = 8%
V0 = 3.00 / (.15 - .08) = $42.86
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus9
Estimating Dividend Growth Rates
g ROE b g ROE b
• g = growth rate in dividends
• ROE = Return on Equity for the firm
• b = plowback or retention percentage rate– (1- dividend payout percentage rate)
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus10
Shifting Growth Rate Model
V Dg
k
D g
k g ko o
t
tt
TT
T
( )
( )
( )
( )( )
1
1
1
1
1
1
2
2V D
g
k
D g
k g ko o
t
tt
TT
T
( )
( )
( )
( )( )
1
1
1
1
1
1
2
2
• g1 = first growth rate
• g2 = second growth rate
• T = number of periods of growth at g1
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus11
Shifting Growth Rate Model: Example
D0 = $2.00 g1 = 20% g2 = 5%
k = 15% T = 3 D1 = 2.40
D2 = 2.88 D3 = 3.46 D4 = 3.63
V0 = D1/(1.15) + D2/(1.15)2 + D3/(1.15)3 +
D4 / (.15 - .05) ( (1.15)3
V0 = 2.09 + 2.18 + 2.27 + 23.86 = $30.40
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus12
Specified Holding Period Model
01
12
2
1 1 1V D
kD
kD P
kN N
N
( ) ( ) ( )...
• PN = the expected sales price for the stock at time N
• N = the specified number of years the stock is expected to be held
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus13
Partitioning Value: Growth and No Growth Components
VE
kPVGO
PVGOD g
k g
E
k
o
o
1
11( )
( )
VE
kPVGO
PVGOD g
k g
E
k
o
o
1
11( )
( )• PVGO = Present Value of Growth
Opportunities• E1 = Earnings Per Share for period 1
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus14
Partitioning Value: Example
• ROE = 20% d = 60% b = 40%
• E1 = $5.00 D1 = $3.00 k = 15%
• g = .20 x .40 = .08 or 8%
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus15
V
NGV
PVGO
o
o
3
15 0886
5
1533
86 33 52
(. . )$42.
.$33.
$42. $33. $9.
V
NGV
PVGO
o
o
3
15 0886
5
1533
86 33 52
(. . )$42.
.$33.
$42. $33. $9.
Partitioning Value: Example
VVoo = value with growth = value with growth
NGVNGVoo = no growth component value = no growth component value
PVGO = Present Value of Growth OpportunitiesPVGO = Present Value of Growth Opportunities
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus16
Price Earnings Ratios
• P/E Ratios are a function of two factors– Required Rates of Return (k)– Expected growth in Dividends
• Uses– Relative valuation– Extensive Use in industry
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus17
P/E Ratio: No expected growth
PE
kP
E k
01
0
1
1
PE
kP
E k
01
0
1
1
• E1 - expected earnings for next year
– E1 is equal to D1 under no growth
• k - required rate of return
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus18
P/E Ratio with Constant Growth
PD
k g
E b
k b ROE
P
E
b
k b ROE
01 1
0
1
1
1
( )
( )
( )
PD
k g
E b
k b ROE
P
E
b
k b ROE
01 1
0
1
1
1
( )
( )
( )
• b = retention ration• ROE = Return on Equity
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus19
Numerical Example: No Growth
E0 = $2.50 g = 0 k = 12.5%
P0 = D/k = $2.50/.125 = $20.00
PE = 1/k = 1/.125 = 8
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus20
Numerical Example with Growth
b = 60% ROE = 15% (1-b) = 40%
E1 = $2.50 (1 + (.6)(.15)) = $2.73
D1 = $2.73 (1-.6) = $1.09
k = 12.5% g = 9%
P0 = 1.09/(.125-.09) = $31.14
PE = 31.14/2.73 = 11.4
PE = (1 - .60) / (.125 - .09) = 11.4
