 Fundamental Analysis – looks at financials, product, mgt., history, etc. PE ratio – Price / E.P.S. Zero-Growth Dividend (preferred stock) Constant Growth Dividend (DCF) Nonconstant Growth

 Technical Analysis – uses charts to predict future prices

 Industry Average PE X Company’s EPS If company EPS = $2.20 and industry average PE = 20, stock should sell around $_____. Factors affected a company’s PE include:  Risk  Expected future growth  Management  Dividends

 Preferred has preference in claims to assets and dividends – must be paid before common.  Preferred dividends – fixed  Common dividends – fluctuate  Preferred usually have no voting rights

P 0 = Value of Preferred Stock = PV of ALL dividends discounted at investor’s Required Rate of Return 52 WeeksYldVol Net HiLoStockSymDiv%PE100sHiLoCloseChg s42½29QuakerOatsOAT ¼34¼-¾ s36¼25RJR NabiscoRN.08p ¾28 5 / / 8 -¾ 23 7 / 8 20RJR Nab pfB / 8 23¾... 7¼5½RJR Nab pfC ½6¼6 3 / /  P 0 =23.75D 1 =2.31D 2 =2.31D 3 =2.31D  = / 8 20RJR Nab pfB / 8 23¾...

P 0 = + + +··· 2.31 (1+ r p ) 2.31 (1+ r p ) (1+ rk p ) 3  52 WeeksYldVol Net HiLoStockSymDiv%PE100sHiLoCloseChg s42½29QuakerOatsOAT ¼34¼-¾ s36¼25RJR NabiscoRN.08p ¾28 5 / / 8 -¾ 23 7 / 8 20RJR Nab pfB / 8 23¾... 7¼5½RJR Nab pfC ½6¼6 3 / /  P 0 =23.75D 1 =2.31D 2 =2.31D 3 =2.31D  = / 8 20RJR Nab pfB / 8 23¾... If an investor expects a 10% return, how much are they willing to pay for the stock?

P 0 = D R = % = $23.10 P 0 = + + +··· 2.31 (1+ r p ) 2.31 (1+ r p ) (1+ rk p ) 3  52 WeeksYldVol Net HiLoStockSymDiv%PE100sHiLoCloseChg s42½29QuakerOatsOAT ¼34¼-¾ s36¼25RJR NabiscoRN.08p ¾28 5 / / 8 -¾ 23 7 / 8 20RJR Nab pfB / 8 23¾... 7¼5½RJR Nab pfC ½6¼6 3 / /  P 0 =23.75D 1 =2.31D 2 =2.31D 3 =2.31D  = / 8 20RJR Nab pfB / 8 23¾... Zero-Growth Div. Model

P 0 = PV of ALL expected dividends discounted at investor’s Required Rate of Return Investors do not know the values of D 1, D 2,...., D N. The future dividends must be estimated. D1D1 D2D2 D3D3 P0P0 DD  P 0 = + + +···  D 1 (1+ r s ) D 2 (1+ r s ) 2 D 3 (1+ r s ) 3

Assume that dividends grow at a constant rate (g). D 1 =D 0 (1+g) D0D0 D 2 =D 0 (1+g) 2 D 3 =D 0 (1+g) 3 D  =D 0 (1+g)  

Requires r > g Reduces to: P 0 = ··· + D 0 (1+ g) (1+ r s ) D 0 (1+ g) 2 (1+ r s ) 2 D 0 (1+ g) 3 (1+ r s ) 3  P 0 = = D 0 (1+g) r – g D 1 r – g D 1 =D 0 (1+g) D0D0 D 2 =D 0 (1+g) 2 D 3 =D 0 (1+g) 3 D  =D 0 (1+g)  

 Gordon Growth Company is expected to pay a dividend of $4 next period and dividends are expected to grow at 6% per year. The required return is 16%.  What is the current price?

 What is the price expected to be in year 4?

 Used with companies that have very high growth rates.  Calculate the PV of cash flows or dividends for the high growth period.  Solve for the PV of cash flows during the constant growth period that are a perpetuity.  The sum of these two is the stock price.

Sales.2M6M86M440M1.4B3B6B10B16B21B23B29B37B50B Net Income -6M-15M7M100M105M 400 M 1.4 B 3B4.2B4.2B6.5B8.5B9.7B 10.7 B

 Can no longer only use constant growth model.  However, growth becomes constant after 3 years.

Supernormal growth followed by constant growth: r=13% = P 0 g = 30% g = 6% D 0 = ^

Supernormal growth followed by constant growth: r =13% = P 0 g = 30% g = 6% D 0 = ^

Supernormal growth followed by constant growth: r s =13% = P 0 g = 30% g = 6% D 0 = ^ Do not add in D 0

01234 r s =13% g = 0% g = 6%  P 3 ...

01234 r s =13% g = 0% g = 6%  P ...

r s =13% g = 0% g = 6%  P ...

Terminal Value – the (present) value, at the horizon date, of all future dividends after that date.

 Samsung just paid $1.00 dividend. It expects 20% and 15% div growth the next two years and then assumes a 5% growth forever. If r=20% what is the most an investor should pay for the stock?

Nonconstant + Constant growth

R = 20% 8.67 = P 0 g = 20%g = 15%g = 5% D 0 = $1.449 P 2 = ^ 0.20 – 0.05 = $9.66

The Jones Company has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with a perpetual annual dividend of $5 per share. If the required return on this stock is currently 20 percent, what should be the stock's market value?

The Jones Company has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with a perpetual annual dividend of $5 per share. If the required return on this stock is currently 20 percent, what should be the stock's market value? 5 ∕.20 = 25

A share of preferred stock pays a quarterly dividend of $2.50. If the price of this preferred stock is currently $50, what is the nominal annual rate of return?

2.5 X 4 = 10/year 10/50 = 20%

McKenna Motors is expected to pay a $1.00 per-share dividend at the end of the year (D1 = $1.00). The stock sells for $20 per share and its required rate of return is 11 percent. The dividend is expected to grow at a constant rate, g, forever. What is the growth rate, g, for this stock? P 0 = D 1 R – g

McKenna Motors is expected to pay a $1.00 per-share dividend at the end of the year (D1 = $1.00). The stock sells for $20 per share and its required rate of return is 11 percent. The dividend is expected to grow at a constant rate, g, forever. What is the growth rate, g, for this stock? D 1 /(R-g) = 20 1/(.11-g) = 20 1 = 2.2 – 20g -1.2 = -20g -1.2/-20 = g.06 = g

A share of common stock has just paid a dividend of $2.00. If the expected long- run growth rate for this stock is 15%, and if investors require a 19% rate of return, what is the price of the stock?

2.00 X (1.15) = 2.30 = D 1 P = 2.30 / ( ) P = 2.30 /.04 P = $57.5

 Suppose a firm is expected to increase dividends by 20% in one year and by 15% in two years. After that dividends will increase at a rate of 5% per year indefinitely. If the last dividend was $1 and the required return is 20%, what is the price of the stock?  Remember that we have to find the PV of all expected future dividends.

 Compute the dividends until growth levels off D 1 = 1(1.2) = $1.20 D 2 = 1.20(1.15) = $1.38 D 3 = 1.38(1.05) = $1.449  Find the expected future price at the beginning of the constant growth period: P 2 = D 3 / (R – g) = / ( ) = 9.66  Find the present value of the expected future cash flows P 0 = 1.20 / (1.2) + ( ) / (1.2) 2 = 8.67

 A firm’s stock is selling for $ They just paid a $1 dividend and dividends are expected to grow at 5% per year.  What is the required return?

 P 0 = $  D 0 = $1  g = 5% per year.  What is the required return?

 P 0 = $10.50  D 0 = $1  g = 5% per year  What is the dividend yield? 1(1.05) / = 10%  What is the capital gains yield? g = 5% Dividend Capital Gains Yield Yield

 Primary vs. Secondary Markets Primary = new-issue market Secondary = existing shares traded among investors  Dealers vs. Brokers Dealer: Maintains an inventor Ready to buy or sell at any time Think “Used car dealer” Broker: Brings buyers and sellers together Think “Real estate broker”

 NYSE Merged with Euronext in 2007 NYSE Euronext merged with the American Stock Exchange in 2008  Members (Historically) Buy a trading license (own a seat) Designated market makers, DMMs (formerly known as “specialists”) Floor brokers

 Operational goal = attract order flow  NYSE DMMs: Assigned broker/dealer  Each stock has one assigned DMM  All trading in that stock occurs at the “DMM’s post” Trading takes place between customer orders placed with the DMMs and “the crowd” “Crowd” = Floor brokers