Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved 1 Chapter 08 Valuing Stocks McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Common Stock Represents ownership in corporation Offers buyers (investors) the potential for current income from dividends and capital appreciation from any stock price increases. Value of common stock based on –Company’s profitability and growth potential –Current market interest rates –Overall stock market conditions Common shareholders – residual claimants 8-2

Stock Markets Provide liquidity through stock exchanges. Investors can convert their shares into cash at any time. Provide means for buyers and sellers to transact stock trades with each other. This liquidity gives many people the confidence to invest. 8-3

Stock Markets New York Stock Exchange (NYSE) American Stock Exchange (AMEX) NASDAQ FTSE Nikkei Bursa Malaysia Singapore Stock Exchange 8-4

Stock Markets  On April 2004, Kuala Lumpur Stock Exchange (KLSE) changed it’s name to Bursa Malaysia.  3 August 2009:  MAIN market – merging of Main Board and Second board industries (C, CP, F, H, IP, IPC, M, Plant, Prop, Reits, SPAC, Tech, TS, CEF)  ACE market – revamp of MESDAQ. - only 5 industries (CP, F, IP, Tech, TS)

Stock Markets Trading Stocks –Buy and sell orders go through the brokerage firm to a market maker (a dealer) at a stock exchange –Quoted bid is highest price at which market makers will buy –Quoted ask (offers) is lowest price at which market makers will sell –Market order is filled at current ask price –Limit order only executed if ask price is below price target 8-6

Stock Markets  In Malaysia, Bursa Malaysia used Win SCORE system:  Placing an order at the stock broking firm  Order are match automatically by the system  All prices which orders are matched and determined by market forces of supply and demand through a process of bids and offers. 8-7

Basic Stock Valuation Present value calculations used Unlike present value for bonds, stock cash flows are unknown –Dividends –Future selling price 8-8

Basic Stock Valuation Find present value of future dividends and future selling price One-year-holding-period timeline example 8-9

Today’s value = present value of next year’s dividend and price Basic Stock Valuation 8-10

Two-year-holding-period timeline example Basic Stock Valuation 8-11

For a holding period of n years, the value of a stock is measured by the present value of dividends over n years plus the sale price Example 8-1 (pg. 270) Basic Stock Valuation 8-12

Stock’s value is the present value of an infinite stream of dividends and no future final sales price P = D 1 + D 2 + D 3 + …. (1+i) (1+i) 2 (1+i) 3 Dividend Discount Model 8-13

Assumes growth rate smaller than discount rate Next year’s dividend ÷ (Discount rate – Growth rate) Example 8-2 (pg. 273) Constant Growth Model 8-14

Preferred Stock Has priority over common stock in bankruptcy Pays a constant dividend Valued using constant-growth model 8-15

Expected Return Investors demand higher returns from higher- risk investments Dividend yield and expected stock price appreciation comprise Expected Return 8-16

Variable Growth-Rate Valuation Combines present-value cash flow with constant-growth-rate model 8-17

Two-Stage Growth Valuation Variable-growth-rate stock Stock value = Present value of each dividend during first growth stage + Present value of second growth stage Example 8-3 (pg. 277) 8-18