1. 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.

2. Common Stock Represents ownership in corporation Value of common stock based on –Company’s profitability and growth potential –Current market interest rates –Overall stock market conditions 8-2

3. Stock Markets Provide liquidity through stock exchanges Provide means for buyers and sellers to transact 8-3

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

5. Stock Markets Stock market indexes –Dow Jones Industrial Average tracks 30 large industry-leading stocks –Standard & Poor’s 500 tracks largest 500 U.S. firms –NASDAQ Composite Index primarily tracks technology firms 8-5

6. Stock Markets Trading Stocks –Quoted bid is highest price at which market makers will buy –Quoted ask is lowest price at which market makers will sell 8-6

7. Stock Markets Trading Stocks –Market order is filled at current ask price –Limit order only executed if ask price is below price target 8-7

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

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

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

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

12. 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 Basic Stock Valuation 8-12

13. Stock’s value is the present value of an infinite stream of dividends and no future final sales price Dividend Discount Model 8-13

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

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

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

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

18. 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 8-18