Chapter 8 The Valuation of Stock

Valuation of Preferred Stock Perpetual preferred Present value of the dividends

Valuation of Perpetual Preferred Stock Pp = Dp/Kp If Dp = $4, Kp =.08 Pp = $4/.08 = $50

Valuation of Preferred Stock Finite life preferred Present value of the dividend and the repayment of the par value

Valuation of Finite Life Preferred Stock Dp = $4 S = $100 N = 30 Kp = .08 V = $54.93

Investing in Common Stock Source of Return Dividends Capital gains

Realized Return Difference in short and long-term capital gains taxation favor capital gains Transactions costs (e.g., commissions) favor dividend income

Common Stock Valuation The determination of what a stock is worth; the stock's intrinsic value If the price exceeds the valuation, buy the stock If the price is less than the valuation, short the stock

Common Stock Valuation Assuming a Fixed Dividend V=D/k Same as perpetual, preferred stock valuation

Common Stock Valuation The Dividend -- Growth Model Value depends on the the required return the dividend the growth in the dividend V = D(1+g)/(k-g)

Dividend - Growth Model Illustration K = .1 (10%) g = .06 (6%) V = $1(1.06)/(.1-.06) = $26.50

Dividend - Growth Model

Dividend - Growth Model Growth may be uneven Fundamental concept still applies

Dividend - Growth Model (uneven growth)

The Risk-adjusted Required Return Adjustment depends on the risk-free rate (rf) the return on the market (rm) the stock's beta

Risk and Required Return

Alternative Valuation Techniques: Use of Ratios Price-earnings ratios Value = Earnings x Earnings multiple

Weaknesses in P/E Ratios Which earnings to use The appropriate multiplier

Other Ratios Price / Sales Price / Book Value