Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

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Presentation transcript:

Fin 307-Stocks Valuation | Dr. Menahem Rosenberg Valuation of Stocks 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Fin 307-Stocks Valuation | Dr. Menahem Rosenberg Asset Valuation Asset Value as Present Value of the Cash Flows it will produce: 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Fin 307-Stocks Valuation | Dr. Menahem Rosenberg Stocks Features Represents (residual) ownership. Ownership implies control. Stockholders elect directors. Directors elect management. Management’s goal: Maximize stock price. Stocks certificate represent proportional ownership. Stocks certificate entitle its holders to proportional distributions (mainly dividend), if there are any. 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

The Discounted Dividend Model A discounted dividend model is any model that computes the value of a share of a stock as the present value of the expected future cash dividends Using (1) above: Let: P0 be the present stock price, Dt - Cash dividend per share at time t r – discount rate 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

The Discounted Dividend Model Alternative view of the Model. Assume a risk less environment Every investor takes a position in a stock for one period only. P1 -the price the next investor will pay for the stock in period 1, after dividend in that period is paid Repeated substitution will result in (2) 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Fin 307-Stocks Valuation | Dr. Menahem Rosenberg The Dividend Model Case 1: Constant Dividend When all dividends are the same D0 = D1 = D2 = …. The dividend stream is treated as a perpetuity 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Fin 307-Stocks Valuation | Dr. Menahem Rosenberg Dividend Growth Model Case 2: Constant Growth Dividend When dividend grow at constant growth rate g from D1 and on and g<r (normal growth) D2 = D1(1+g) D3 = D2(1+g) = D1(1+g)2 The dividend stream is treated as a constant growth perpetuity 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Fin 307-Stocks Valuation | Dr. Menahem Rosenberg Dividend Growth Model Case 3: Limited abnormal growth continued by Constant Growth Dividend Let dividend grow at g1> r rate for t periods, and from t+1 grow forever at a constant growth rate g2< r . Compute (6.1) Dt+1= Dt (1+ g2) = D0(1+ g1)t (1+ g2) 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Fin 307-Stocks Valuation | Dr. Menahem Rosenberg Dividend Growth Model Which can be substituted with a growing annuity 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Where is Growth Coming from ? Review: Net Income = Retained earning + Dividend Retained earning are additions to equity, therefore, next period the increase in NI = ROE * Retained earning Therefore, growth (7) g= ROE*(Retention Ratio) 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

Price and Investment Opportunities The price of a stock that pays out 100% of its earning : If the firm decides to retain earning and invest in new project, its value will increase by exactly the projects’ NPV. 7/23/2019 Fin 307-Stocks Valuation | Dr. Menahem Rosenberg