1. 1 Chapter 5: Stock Valuation Topics Determining stock values Efficient markets

2. 2 Different Approaches for Valuing Common Stock Dividend growth model Using the multiples of comparable firms Free cash flow method (covered in Chapter 11)

3. 3 For a constant growth stock: The constant growth dividend discount (Gordon) model: P 0 = ^D 0 (1+g) r s - g = D1D1

4. 4 Rearrange model to rate of return form: P 0 = ^ D1D1 r s - g to D1D1 P0P0 rsrs ^ = + g.

5. 5 Nonconstant Growth Model A firm is expected to have high growth for n years, followed by constant growth at rate g c. Steps: 1. Calculate dividends to n+1. 2. Calculate the stock value at n using constant growth model and g C. 3. The stock value at t=0 (P 0 ) is the present value of D 1, to D n plus the present value of P n, discounted at the req ret (r s ).

6. 6 Using Stock Price Multiples to Estimate Stock Price A number of valuation multiples can be used to provide confirmation of stock or firm value obtained by more sophisticated methods’ Examples: P/E Price/Book Value

7. Valuation multiples To use valuation multiples, we calculate the average relationship for comparable firms and use them to calculate the value of our firm’s stock. 7

8. 8 Using Entity Valuation Multiples The P/E ratio can be used to estimate the per share value directly. Some valuation multiples are based on total (entity) value, however. Calculate the average entity ratio for a sample of comparable firms. For example, V/Customers V/Sales Revenue The result is the total value of the firm.

9. 9 Using Entity Multiples (Continued) Find the entity value of the firm in question. For example, Multiply the firm’s sales by the V/Sales multiple. Or, multiply the firm’s # of customers by the V/Customers ratio The result is the total value of the firm. Subtract the firm’s debt to get the total value of equity. Divide by the number of shares to get the price per share.