Chapter 09.ppt
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Chapter 09.ppt Chapter 09.ppt Presentation Transcript

  • CHAPTER 9 Stocks and Their Valuation
    • Features of common stock
    • Determining common stock values
    • Preferred stock
  • Facts about common stock
    • Represents ownership
    • Ownership implies control
    • Stockholders elect directors
    • Directors elect management
    • Management’s goal: Maximize the stock price
  • Intrinsic Value and Stock Price
    • Outside investors, corporate insiders, and analysts use a variety of approaches to estimate a stock’s intrinsic value (P 0 ).
    • In equilibrium we assume that a stock’s price equals its intrinsic value.
      • Outsiders estimate intrinsic value to help determine which stocks are attractive to buy and/or sell.
      • Stocks with a price below (above) its intrinsic value are undervalued ( overvalued ).
  • Determinants of Intrinsic Value and Stock Prices (Figure 1-1)
  • Different approaches for estimating the intrinsic value of a common stock
    • Dividend growth model
    • Corporate value model
    • Using the multiples of comparable firms
  • Dividend growth model
    • Value of a stock is the present value of the future dividends expected to be generated by the stock.
  • Constant growth stock
    • A stock whose dividends are expected to grow forever at a constant rate, g.
    • D 1 = D 0 (1+g) 1
    • D 2 = D 0 (1+g) 2
    • D t = D 0 (1+g) t
    • If g is constant, the dividend growth formula converges to:
  • Future dividends and their present values $ 0.25 Years (t) 0
  • What happens if g > r s ?
    • If g > r s , the constant growth formula leads to a negative stock price, which does not make sense.
    • The constant growth model can only be used if:
      • r s > g
      • g is expected to be constant forever
  • If r RF = 7%, r M = 12%, and b = 1.2, what is the required rate of return on the firm’s stock?
    • Use the SML to calculate the required rate of return (r s ):
    • r s = r RF + (r M – r RF )b
    • = 7% + (12% - 7%)1.2
    • = 13%
  • If D 0 = $2 and g is a constant 6%, find the expected dividend stream for the next 3 years, and their PVs. 1.8761 1.7599 D 0 = 2.00 1.6509 r s = 13% g = 6% 0 1 2.247 2 2.382 3 2.12
  • What is the stock’s intrinsic value?
    • Using the constant growth model:
  • What is the expected market price of the stock, one year from now?
    • D 1 will have been paid out already. So, P 1 is the present value (as of year 1) of D 2 , D 3 , D 4 , etc.
    • Could also find expected P 1 as:
  • What are the expected dividend yield, capital gains yield, and total return during the first year?
    • Dividend yield
      • = D 1 / P 0 = $2.12 / $30.29 = 7.0%
    • Capital gains yield
      • = (P 1 – P 0 ) / P 0
      • = ($32.10 - $30.29) / $30.29 = 6.0%
    • Total return (r s )
      • = Dividend Yield + Capital Gains Yield
      • = 7.0% + 6.0% = 13.0%
  • What would the expected price today be, if g = 0?
    • The dividend stream would be a perpetuity.
    2.00 2.00 2.00 0 1 2 3 r s = 13% ...
  • Supernormal growth: What if g = 30% for 3 years before achieving long-run growth of 6%?
    • Can no longer use just the constant growth model to find stock value.
    • However, the growth does become constant after 3 years.
  • Valuing common stock with nonconstant growth  P ^ r s = 13% g = 30% g = 30% g = 30% g = 6%  0.06 $66.54 3 4.658 0.13   2.301 2.647 3.045 46.114 54.107 = P 0 0 1 2 3 4 D 0 = 2.00 2.600 3.380 4.394 ... 4.658
  • Find expected dividend and capital gains yields during the first and fourth years.
    • Dividend yield (first year)
      • = $2.60 / $54.11 = 4.81%
    • Capital gains yield (first year)
      • = 13.00% - 4.81% = 8.19%
    • During nonconstant growth, dividend yield and capital gains yield are not constant, and capital gains yield ≠ g.
    • After t = 3, the stock has constant growth and dividend yield = 7%, while capital gains yield = 6%.
  • Nonconstant growth: What if g = 0% for 3 years before long-run growth of 6%? r s = 13% g = 0% g = 0% g = 0% g = 6% 0.06  $30.29 P 3 2.12 0.13    1.77 1.57 1.39 20.99 25.72 = P 0 ^ 0 1 2 3 4 D 0 = 2.00 2.00 2.00 2.00 ... 2.12
  • Find expected dividend and capital gains yields during the first and fourth years.
    • Dividend yield (first year)
      • = $2.00 / $25.72 = 7.78%
    • Capital gains yield (first year)
      • = 13.00% - 7.78% = 5.22%
    • After t = 3, the stock has constant growth and dividend yield = 7%, while capital gains yield = 6%.
  • If the stock was expected to have negative growth (g = -6%), would anyone buy the stock, and what is its value?
    • The firm still has earnings and pays dividends, even though they may be declining, they still have value.
  • Find expected annual dividend and capital gains yields.
    • Capital gains yield
      • = g = -6.00%
    • Dividend yield
      • = 13.00% - (-6.00%) = 19.00%
    • Since the stock is experiencing constant growth, dividend yield and capital gains yield are constant. Dividend yield is sufficiently large (19%) to offset a negative capital gains.
  • Corporate value model
    • Also called the free cash flow method. Suggests the value of the entire firm equals the present value of the firm’s free cash flows.
    • Remember, free cash flow is the firm’s after-tax operating income less the net capital investment
      • FCF = NOPAT – Net capital investment
  • Applying the corporate value model
    • Find the market value (MV) of the firm, by finding the PV of the firm’s future FCFs.
    • Subtract MV of firm’s debt and preferred stock to get MV of common stock.
    • Divide MV of common stock by the number of shares outstanding to get intrinsic stock price (value).
  • Issues regarding the corporate value model
    • Often preferred to the dividend growth model, especially when considering number of firms that don’t pay dividends or when dividends are hard to forecast.
    • Similar to dividend growth model, assumes at some point free cash flow will grow at a constant rate.
    • Terminal value (TV N ) represents value of firm at the point that growth becomes constant.
  • Given the long-run g FCF = 6%, and WACC of 10%, use the corporate value model to find the firm’s intrinsic value. g = 6% r = 10% 21.20 0 1 2 3 4 -5 10 20 ... 416.942 -4.545 8.264 15.026 398.197 21.20 530 = = TV 3 0.10 0.06 -
  • If the firm has $40 million in debt and has 10 million shares of stock, what is the firm’s intrinsic value per share?
    • MV of equity = MV of firm – MV of debt
    • = $416.94 - $40
    • = $376.94 million
    • Value per share = MV of equity / # of shares
    • = $376.94 / 10
    • = $37.69
  • Firm multiples method
    • Analysts often use the following multiples to value stocks.
      • P / E
      • P / CF
      • P / Sales
    • EXAMPLE: Based on comparable firms, estimate the appropriate P/E. Multiply this by expected earnings to back out an estimate of the stock price.
  • What is market equilibrium?
    • In equilibrium, stock prices are stable and there is no general tendency for people to buy versus to sell.
    • In equilibrium, two conditions hold:
      • The current market stock price equals its intrinsic value (P 0 = P 0 ).
      • Expected returns must equal required returns.
    ^
  • Market equilibrium
    • Expected returns are determined by estimating dividends and expected capital gains.
    • Required returns are determined by estimating risk and applying the CAPM.
  • How is market equilibrium established?
    • If price is below intrinsic value …
      • The current price (P 0 ) is “too low” and offers a bargain.
      • Buy orders will be greater than sell orders.
      • P 0 will be bid up until expected return equals required return.
  • How are the equilibrium values determined?
    • Are the equilibrium intrinsic value and expected return estimated by managers or are they determined by something else?
      • Equilibrium levels are based on the market’s estimate of intrinsic value and the market’s required rate of return, which are both dependent upon the attitudes of the marginal investor.
  • Preferred stock
    • Hybrid security.
    • Like bonds, preferred stockholders receive a fixed dividend that must be paid before dividends are paid to common stockholders.
    • However, companies can omit preferred dividend payments without fear of pushing the firm into bankruptcy.
  • If preferred stock with an annual dividend of $5 sells for $50, what is the preferred stock’s expected return?
    • V p = D / r p
    • $50 = $5 / r p
    • r p = $5 / $50
    • = 0.10 = 10%
    ^