Equity Valuation Models

Slides:



Advertisements
Similar presentations
Equity Valuation Models
Advertisements

The Value of Common Stocks. Topics Covered  How Common Stocks are Traded  How To Value Common Stock  Capitalization Rates  Stock Prices and EPS 
Equity Valuation CHAPTER 12.
1 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Fin2808: Investments Spring, 2010 Dragon Tang Lectures 13 & 14 Equity Valuation Models March.
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Equity Valuation 13 Bodie, Kane, and Marcus Essentials of Investments,
1 1 Ch17, 18, 19 – MBA 566 Security Valuation and Analysis Macroeconomic and Industry Analysis/Fundamental Analysis Equity Valuation Ratio analysis.
McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Equity Valuation CHAPTER 13.
1 Solvay Business School – Université Libre de Bruxelles 1 Part 2 : Asset Valuation & Portfolio theory (6 hrs) 2.1. Case study 1 : buy side & sell side.
Equity Valuation Models Chapter 18. Basic Types of Models - Balance Sheet Models - Dividend Discount Models - Price/Earning Ratios Estimating Growth Rates.
Chapter 13 Equity Valuation
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.
The McGraw-Hill Companies, Inc., 2000
Copyright © 2006 McGraw Hill Ryerson Limited6-1 prepared by: Sujata Madan McGill University Fundamentals of Corporate Finance Third Canadian Edition.
Lecture 7 The Value of Common Stocks Managerial Finance FINA 6335 Ronald F. Singer.
Equity Valuation Models
Fall-02 Investments Zvi Wiener tel: Equity Valuation Methods BKM Ch.
The Value of Common Stocks Chapter 4. Topics Covered  How Common Stocks are Traded  How To Value Common Stock  Capitalization Rates  Stock Prices.
Equity Valuation Chapter 13.
INVESTMENTS | BODIE, KANE, MARCUS Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written.
5- 1 Outline 5: Stock & Bond Valuation  Bond Characteristics  Bond Prices and Yields  Stocks and the Stock Market  Book Values, Liquidation Values.
Macroeconomic and Industry Analysis
Chapter 13 Equity Valuation Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.
7- 1 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Fundamentals of Corporate Finance Sixth Edition Richard.
Chapter 13 Equity Valuation
McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Macroeconomic and Industry Analysis.
CHAPTER 18 Investments Equity Valuation Models Slides by Richard D. Johnson Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin.
Comm W. Suo Slide 1. comm W. Suo Slide 2 Estimating Growth  Balance sheet  Historical  Analyst forecast.
Chapter 13 Equity Valuation 13-1.
Equity Valuation Models. Valuation by Comparables FA –Identification of mispriced stocks Relative to some „true value“ –Derived from financial data –
CORPORATE FINANCE Week 4 – 17&19 Oct Stock and Company Valuation – Dividend Growth Model, Free Cash Flow Model I. Ertürk Senior Fellow in Banking.
Chapter 6 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc.
7- 1 McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved Fundamentals of Corporate Finance Sixth Edition Richard.
Chapter 18 Equity Valuation. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Fundamental Stock Analysis: Models of Equity.
1 Security Valuation and Analysis Macroeconomic/Industry Analysis Security valuation Ratio analysis MBA566: chapter
McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Equity Valuation CHAPTER 13.
Chapter 12 Equity Valuation. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Fundamental Stock Analysis: Models of Equity.
Chapter 7 Valuing Stocks TOPICS COVERED Stocks and the Stock Market Valuing Common Stocks Simplifying the Dividend Discount Model Growth Stocks and Income.
Equity Valuation 1.  Identify stocks that are mispriced relative to true value  Compare the actual market price and the true price estimated from various.
The Investment Decision Process Determine the required rate of return Evaluate the investment to determine if its market price is consistent with your.
Equity Valuation VALUATION BY COMPARABLES  Basic Types of Models ◦ Balance Sheet Models ◦ Dividend Discount Models ◦ Price/Earnings Ratios.
Common Stock Valuation
Chapter 4 Principles of Corporate Finance Eighth Edition Value of Bond and Common Stocks Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies,
EQUITY VALUATION. Claims on Cash Flows of Firm Investors forego consumption and invest expecting future returns Risk is associated with the investment.
Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 1 Chapter 13.
Investment Management © 2008 Equity Valuation Models Lectured by Chandra Wijaya.
12-1 McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. CHAPTER 12 Equity Valuation.
Class Business Upcoming Case Clip Proforma Assignment.
Stock Valuation 1Finance - Pedro Barroso. Present Value of Common Stocks The value of any asset is the present value of its expected future cash flows.
Chapter 13 Equity Valuation Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.
 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 18-1 Equity Valuation Models Chapter 18.
Chapter 13 Equity Valuation Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.
CHAPTER 18 Equity Valuation Models. Topics Security analysis –Fundamental analysis –Technical analysis Intrinsic value versus market price Equity valuation.
Equity Valuation. Methods Balance Sheet Models Discounted Cash Flow Models Multiplier Models.
McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Equity Valuation CHAPTER 12.
Chapter 13 Equity Valuation Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.
Chapter 2 Discounted Dividend Valuation Equity Asset Valuation: Valuation - by John D Stowe, Thomas R Robinson, Jerald.
Valuation Fundamentals
Common Stock Valuation
13 Equity Valuation Bodie, Kane, and Marcus
Chapter 4 The Value of Common Stocks Principles of Corporate Finance
Equity Valuation Models
Equity Valuation Models
Chapter 13 Equity Valuation.
Fundamentals of Investments
CHAPTER 13 Equity Valuation.
Lecture 4 The Value of Common Stocks
Valuation by Comparables
Investments: Analysis and Management Common Stock Valuation
Presentation transcript:

Equity Valuation Models Chapter Eighteen Equity Valuation Models

Valuation: Fundamental Analysis Fundamental analysis models a company’s value by assessing its current and future profitability. The purpose of fundamental analysis is to identify mispriced stocks relative to some measure of “true” value derived from financial data. See the type of traders slide.

Valuation Methods Valuation by comparables Price/Earning Ratios Balance Sheet Models Book Value http://finance.yahoo.com/q/ks?s=CSCO http://biz.yahoo.com/ic/814.html Expected Returns vs. Required Return CAPM Intrinsic Value vs. Market price Dividend Discount Models

Limitations of Book Value Book values are based on historical cost, not actual market values. It is possible, but uncommon, for market value to be less than book value. “Floor” or minimum value is the liquidation value per share. Tobin’s q is the ratio of market price to replacement cost.

Intrinsic Value vs. Market Price The return on a stock is composed of dividends and capital gains or losses. The expected HPR may be more or less than the required rate of return, based on the stock’s risk.

Required Return CAPM gives the required return, k: If the stock is priced correctly, k should equal expected return. k is the market capitalization rate.

Expected Return vs. Required Return k is the required return given stock’s risk (beta) E(r) is the return you’ll get if you buy the stock at its market price (i.e., consensus value of all market participants) Trading Signal: E(r) > k Buy E(r) < k Sell or Short Sell E(r) = k Hold or Fairly Priced

Intrinsic Value and Market Price The intrinsic value (IV) is the “true” value, according to a model. The market value (MV = P0) is the consensus value of all market participants Trading Signal: IV > MV Buy IV < MV Sell or Short Sell IV = MV Hold or Fairly Priced

Dividend Discount Models (DDM) V0 =current value; Dt=dividend at time t; k = required rate of return The DDM says the stock price should equal the present value of all expected future dividends into perpetuity.

Constant Growth DDM V0 = intrinsic value estimate k= risk-adjusted required return (from CAPM) g= dividend growth rate Alternatively, E(r) = D1/P0 + g, where P0 = market price

Example 18.1 Preferred Stock and the DDM No growth case Value a preferred stock paying a fixed dividend of $2 per share when the discount rate is 8%:

Example 18.2 Constant Growth DDM A stock just paid an annual dividend of $3/share. The dividend is expected to grow at 8% indefinitely, and the market capitalization rate (from CAPM) is 14%. If P0 = 45, E(r) = D1/P0 + g = 3.24/45 + 0.08 = 0.152 Hence, IV > MV (P0) and E(r) > k E(r) is the input data for “Forecast” (H6 through H12) in http://highered.mheducation.com/sites/dl/free/0077861671/1018535/BKM_10e_Ch07_Appendix_Spreadsheets.xls

DDM Implications The constant-growth rate DDM implies that a stock’s value will be greater: The larger its expected dividend per share. The lower the market capitalization rate, k. The higher the expected growth rate of dividends. The stock price is expected to grow at the same rate as dividends.

Estimating Dividend Growth Rates g = growth rate in dividends ROE = Return on Equity for the firm b = plowback or retention percentage rate (1- dividend payout percentage rate)

Figure 18.1 Dividend Growth for Two Earnings Reinvestment Policies

Present Value of Growth Opportunities The value of the firm equals the value of the assets already in place, the no-growth value of the firm, Plus the NPV of its future investments, Which is called the present value of growth opportunities or PVGO.

Present Value of Growth Opportunities Price = No-growth value per share + PVGO

Example 18.4 Growth Opportunities Firm reinvests 60% of its earnings in projects with ROE of 10%, capitalization rate is 15%. Expected year-end dividend is $2/share, paid out of earnings of $5/share. g=ROE x b = 10% x .6 = 6%

Example 18.4 Growth Opportunities PVGO =Price per share – no-growth value per share

Life Cycles and Multistage Growth Models Expected dividends for Honda: 2013 $.78 2015 $ .92 2014 $.85 2016 $1.00 Since the dividend payout ratio is 25% and ROE is 10%, the “steady-state” growth rate is 7.5%.

Honda Example Honda’s beta is 0.95 and the risk-free rate is 2%. If the market risk premium is 8%, then k is: k=2% + 0.95(8%) = 9.6% Therefore:

Honda Example Finally, In 2012, one share of Honda Motor Company Stock was worth $32.88.

Price-Earnings Ratio and Growth The ratio of PVGO to E / k is the ratio of firm value due to growth opportunities to value due to assets already in place (i.e., the no-growth value of the firm, E / k ).

Price-Earnings Ratio and Growth When PVGO=0, P0=E1 / k. The stock is valued like a nongrowing perpetuity. P/E rises dramatically with PVGO. High P/E indicates that the firm has ample growth opportunities.

Price-Earnings Ratio and Growth P/E increases: As ROE increases As plowback increases, as long as ROE>k

Table 18.3 Effect of ROE and Plowback on Growth and the P/E Ratio

P/E and Growth Rate Wall Street rule of thumb: The growth rate is roughly equal to the P/E ratio. “If the P/E ratio of Coca Cola is 15, you’d expect the company to be growing at about 15% per year, etc. But if the P/E ratio is less than the growth rate, you may have found yourself a bargain.” Quote from Peter Lynch in One Up on Wall Street.

P/E Ratios and Stock Risk When risk is higher, k is higher; therefore, P/E is lower.

Pitfalls in P/E Analysis Use of accounting earnings Earnings Management Choices on GAAP Inflation Reported earnings fluctuate around the business cycle http://www.todayevery.com/share/rJg5dxJG5e?hint=SB11849978673534134861004582647572763749082?responsive=y/articles

Figure 18.3 P/E Ratios of the S&P 500 Index and Inflation

Figure 18.4 Earnings Growth for Two Companies

PE Ratios

Figure 18.6 P/E Ratios for Different Industries, 2012

Other Comparative Value Approaches Price-to-book ratio Price-to-cash-flow ratio Price-to-sales ratio

Figure 18.7 Market Valuation Statistics

Free Cash Flow Approach Value the firm by discounting free cash flow at WACC. Free cash flow to the firm, FCFF, equals: After tax EBIT Plus depreciation Minus capital expenditures Minus increase in net working capital

Comparing the Valuation Models In practice Values from these models may differ Analysts are always forced to make simplifying assumptions Problems with DCF Calculations are sensitive to small changes in inputs Growth opportunities and growth rates are hard to pin down

The Aggregate Stock Market Use of earnings multiplier approach at aggregate level Some analysts use aggregate version of DDM S&P 500 taken as leading economic indicator

Table 18.4 S&P 500 Price Forecasts Under Various Scenarios

Robert Shiller’s Results

Robert Shiller’s Model