8-0 Stock Valuation Chapter 8 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Chapter Outline Common Stock Valuation Features of Stocks Stock Market Reporting 1

Common Stock Valuation Estimating Dividends - 3 Special Cases: 1. Zero Growth 2. Constant Growth 3. Non-constant growth The Comparables Approach 2

1. Zero Growth If the same dividends are expected at regular intervals forever, then this is like preferred stock and is valued as a. PV = C / R P = D / R 3

Zero Growth Example A stock is expected to pay a $2 dividend forever and the market rate of return is 10%. What is the value of the stock? 4

2. Constant Growth Dividends are expected to grow at a constant percent per period forever. Use the “Dividend Growth Model”: 5

Constant Growth Example: The current dividend of a stock is $5 and the expected growth rate is 3%. The market rate of return is 11%. What is the price of the stock today? What is the price in four years? 6

3. Non-Constant Growth Non-constant growth really means: constant growth after period t. 1. Compute the future price at the time (t) when the dividends grow at a constant rate forever, using the dividend growth model. 2. Find the present value of the expected future cash flows (i.e. the irregular dividends and the future price at time t). 7

Non-Constant Growth Example I The next three dividends for a company are expected to be $.50, $.75, and $1.50. Then the dividends are expected to grow at a constant 5% forever. If the required return for the company is 10%, what is the present value of the stock? 8

Non-Constant Growth Example II The next dividend of a common stock is expected to be $0.70. The dividends will grow at 6% for the next two years and then grow at 4% forever. If the required return for the company is 8%, what is the present value of the stock? 9

Common Stock Valuation: The “Comparables” Approach 1. Pick a “comparable” stock (similar g) and find its PE ratio. 2. Rearrange the PE formula to solve for the price per share. PE = price per share/earnings per share price per share = PE x earnings per share For example: you are trying to value the stock of a company. The company has $2 in earnings per share. If a comparable firm (with a similar growth rate) has a PE ratio of 15, what is the value of the stock? Price per share = 10

Features of Stock Voting Rights 1. cumulative voting: all directors are voted “at once” # of votes = # of shares owned x N # of shares required to guarantee a seat = [ 1/(N+1) x # of shares outstanding] +1 where N = # of directors to be elected 2. straight voting: directors are voted “one at a time” # of votes = # of shares owned # of shares required to guarantee a seat = [ # of shares outstanding / 2] +1 11

Features of Stock Continued Voting Rights Example: Assume a company has 10,000 shares outstanding and 4 directors need to be elected in the next meeting. How many shares does it take to guarantee a seat on the board under cumulative and under straight voting? 12

Features of Stock Continued Proxy voting Classes of stock Dividends 13

Stock Market Reporting 14