Stock Valuation

Learning Goals

What is stock valuation model.How to value good and bad stock

Introduction Purpose – to obtain a standard of performance that

can be used to judge the investment merits of a share. It is called stock intrinsic value. It indicates the future risk and return performance of a security.

To look at whether a stock is under or over valued are by comparing its intrinsic value and its current market price.

Price of a share depends on investor’s expectations about the future behavior of the security. If the outlook for the company and its stock is good, the price will probably be bid up. If the condition is deteriorating, the price of the stock will probably go down.

Value of stock can be determined based on:Par Value - refers to the stated or face value,

value of the stock.Book Value - represents the amount of

stockholders’ equity in the firm.Market Value / Market Capitalization is simply

the prevailing market price of an issue traded in stock exchange.

Investment value is determined based on expectations of the return and risk behavior of a stock.

Stock Valuation ModelMarket Value Approach

The company’s capitalization / = number of shares x price per sharetotal market value outstanding

Book Value ApproachBV per share = Total shareholder’s equity - Preferred shares

Common shares outstanding.

Asset Value ApproachAV = Residual Value_____

Common Stock Outstanding

Price Earning Ratio (P/E) ApproachMarket Value per Share = Forecasted P/E x Expected EPS

Net Tangible Assets (NTA) ApproachNTA = total assets of a company

Number of share outstanding

Dividend Valuation ModelThe value of a share is a function of all future

dividends it is expected to provide over an infinite time horizon.

3 versions of the dividend valuation model:The zero-growth model - assume that dividends

will not grow over timeThe constant-growth model – assumes that

dividends will grow by a fixed/constant rate over time

The variables-growth model – which assumes that the rate of growth in dividends varies over time.

 

Zero Growth Value of a share of stock = Annual dividends

Required rate of returnP0 = D1

kFor example, if a stock paid a (constant) dividend of RM 3

a share and you wanted to earn 10% on your investment, the value of the stock would be RM 30 a share

(RM 3/0.10 = RM 30)If the capitalization rate goes up to, say 15%, the price of

the stock will fall to RM20 (3/0.15)

Constant Growth P0 = D0 x (1 + g )1_ + D0 x (1 + g )2 + … + D0 x (1 +

g )n_ (1+k s ) 1 (1+k s ) 2 (1+k s ) n

P0 = (D0 x PVIF1) + (D1 x PVIF2) + ……… + (Dn x PVIFn)

P0 = D1 = D0 (1+g) k-g k-g

A stock currently pays an annual dividend of RM1.75 a share. Growing at a rate of 8% a year, and you expect they will continue to do so into the future. In addition, you feel that because of the risks involved, the investment should carry a required rate of return of 12%. Given this information: 

Value of a share of stock = D0 (1+g)

k-g = RM1.75 (1.08)

0.12 – 0.08 = RM 47.25

Variable Growth Step 1:

D1 = D0 x (1 + g1 ) 1

D2 = D1 x (1 + g1)

D3 = D2 x (1 + g1) …..

Dn = Dn-1 x (1 + g1)

Step 2:

P0 = D1 _ + D2 _ + … …+ Dn__

(1+k s ) 1 (1+k s ) 2 (1+k s ) n

P0 = (D1 x PVIF1,k )+ (D2 x PVIF2,k) + ……… + (Dn x PVIFn,k)

Step 3:MP = Dn x (1 + g2 )n_ x 1__

(k s - g2 ) (1+k s ) n

Dn x (1 + g2 )n_ x PVIFn,k

(k s - g2 )

Step 4:

Po = Po in step 2 + MP in step 3