Chapter 13 Equity Valuation.

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Presentation transcript:

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 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

Dividend Discount Models: General Model V0 = Value of Stock Dt = Dividend k = required return

No Growth Model Stocks that have earnings and dividends that are expected to remain constant Preferred Stock

No Growth Model: Example E1 = D1 = $5.00 k = .15 V0 = $5.00 / .15 = $33.33

Constant Growth Model g = constant perpetual growth rate

Constant Growth Model: Example E1 = $5.00 b = 40% k = 15% (1-b) = 60% D1 = $3.00 g = 8% V0 = 3.00 / (.15 - .08) = $42.86

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)

Shifting Growth Rate Model g1 = first growth rate g2 = second growth rate T = number of periods of growth at g1

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

Specified Holding Period Model PN = the expected sales price for the stock at time N N = the specified number of years the stock is expected to be held

Partitioning Value: Growth and No Growth Components PVGO = Present Value of Growth Opportunities E1 = Earnings Per Share for period 1

Partitioning Value: Example ROE = 20% d = 60% b = 40% E1 = $5.00 D1 = $3.00 k = 15% g = .20 x .40 = .08 or 8%

Partitioning Value: Example Vo = value with growth NGVo = no growth component value PVGO = Present Value of Growth Opportunities

Price Earnings Ratios P/E Ratios are a function of two factors Uses Required Rates of Return (k) Expected growth in Dividends Uses Relative valuation Extensive Use in industry

P/E Ratio: No expected growth E1 - expected earnings for next year E1 is equal to D1 under no growth k - required rate of return

P/E Ratio with Constant Growth b = retention ration ROE = Return on Equity

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

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