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Chapter 8 Stock Valuation
Stock Valuation <ul><li>Learning Goals </li></ul><ul><ul><li>Explain the role that a company’s future plays in  stock valu...
Stock Valuation <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Use other types of present-value-based models to der...
Valuing a Company and Its Future <ul><li>The single most important issue in the stock valuation process is what a stock wi...
Table 8.1  Comparative Dollar Based and Common-Size Income Statements
Steps in Valuing a Company <ul><li>Three steps are necessary to project key financial variables into the future: </li></ul...
Step 1: Forecast Future  Sales and Profits <ul><li>Forecasted Future Sales based upon: </li></ul><ul><ul><li>“ Naïve” appr...
Step 1: Forecast Future  Sales and Profits (cont’d) <ul><li>Example: Assume last year’s sales were $100 million, revenue g...
Step 2: Forecast Future EPS <ul><li>Forecasted outstanding shares of common stock based upon: </li></ul><ul><ul><li>“ Naïv...
Step 2: Forecast Future EPS (cont’d) <ul><li>Example: Assume estimated profits are $6.5 million, 2 million shares of commo...
Step 2: Forecast Future Dividends <ul><li>Forecasted Dividend Payout ratio  based upon: </li></ul><ul><ul><li>“Naïve” appr...
Step 2: Forecast Future  Dividends (cont’d) <ul><li>Example: Assume estimated profits are $6.5 million, 2 million shares o...
Step 3: Forecast P/E Ratio <ul><li>Estimated P/E ratio based upon: </li></ul><ul><ul><li>“Average market multiple” of all ...
Step 3: Forecast P/E Ratio <ul><li>Estimated P/E ratio is function of several variables, including: </li></ul><ul><ul><li>...
Step 3: Forecast Future Stock Price <ul><li>Example: Assume estimated EPS are $3.25 and the estimated P/E ratio is 17.5 ti...
Table 8.4  Summary Forecast Statistics, Universal Office Furnishings
Using Stock Valuation <ul><li>Once we have an estimated future stock price, we can compare it to the current market price ...
The Valuation Process <ul><li>Valuation  is a process by which an investor uses risk and return concepts to determine the ...
Required Rate of Return <ul><li>Required Rate of Return  is the return necessary to compensate an investor for the risk in...
Required Rate of Return (cont’d) <ul><li>Example: Assume a company has a beta of 1.30, the risk-free rate is 5.5% and the ...
Other Stock Valuation Methods <ul><li>Dividend Valuation Model </li></ul><ul><ul><li>Zero growth </li></ul></ul><ul><ul><l...
Dividend Valuation Model:  Zero Growth <ul><li>Uses present value to value stock </li></ul><ul><li>Assumes stock value is ...
Dividend Valuation Model:  Constant Growth <ul><li>Uses present value to value stock </li></ul><ul><li>Assumes stock value...
Dividend Valuation Model:  Variable Growth <ul><li>Uses present value to value stock </li></ul><ul><li>Assume stock value ...
Dividends-and-Earnings Approach <ul><li>Very similar to variable-growth DVM </li></ul><ul><li>Uses present value to value ...
Price/Earnings (P/E) Approach <ul><li>Future price is based upon the appropriate P/E ratio and forecasted EPS </li></ul><u...
Price-to-Cash-Flow (P/CF) Approach <ul><li>Similar to P/E approach, but substitutes projected cash flow for earnings </li>...
Price-to-Sales (P/S) Approach <ul><li>Similar to P/E approach, but substitutes projected sales for earnings </li></ul><ul>...
Price-to-Book-Value  (P/BV) Approach <ul><li>Similar to P/E approach, but substitutes book value for earnings </li></ul>
Chapter 8 Review <ul><li>Learning Goals </li></ul><ul><ul><li>Explain the role that a company’s future plays in  stock val...
Chapter 8 Review (cont’d) <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Use other types of present-value-based mod...
Chapter 8 Additional Chapter Art
Table 8.2  Average Market P/E Multiples 1977–2006
Table 8.3  Selected Historical Financial Data, Universal Office Furnishings
Table 8.5  Using the Variable-Growth DVM to Value Sweatmore Stock
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Transcript of "Chapter 7"

  1. 1. Chapter 8 Stock Valuation
  2. 2. Stock Valuation <ul><li>Learning Goals </li></ul><ul><ul><li>Explain the role that a company’s future plays in stock valuation. </li></ul></ul><ul><ul><li>Develop a forecast of a stock’s cash flow, expected dividends and share price. </li></ul></ul><ul><ul><li>Discuss the concepts of intrinsic value and required rates of return, and note how they are used. </li></ul></ul><ul><ul><li>Determine the underlying value of a stock using various dividend valuation models. </li></ul></ul>
  3. 3. Stock Valuation <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Use other types of present-value-based models to derive the value of a stock as well as alternative price-relative procedures. </li></ul></ul><ul><ul><li>Gain a basic appreciation of the procedures used to value different types of stocks, from traditional dividend-paying shares to more growth-oriented stocks. </li></ul></ul>
  4. 4. Valuing a Company and Its Future <ul><li>The single most important issue in the stock valuation process is what a stock will do in the future </li></ul><ul><li>Value of a stock depends upon its future returns from dividends and capital gains/losses </li></ul><ul><li>We use historical data to gain insight into the future direction of a company and its profitability </li></ul><ul><li>Past results are not a guarantee of future results </li></ul>
  5. 5. Table 8.1 Comparative Dollar Based and Common-Size Income Statements
  6. 6. Steps in Valuing a Company <ul><li>Three steps are necessary to project key financial variables into the future: </li></ul><ul><ul><li>Step 1: Forecast future sales & profits </li></ul></ul><ul><ul><li>Step 2: Forecast future EPS and dividends </li></ul></ul><ul><ul><li>Step 3: Forecast future stock price </li></ul></ul>
  7. 7. Step 1: Forecast Future Sales and Profits <ul><li>Forecasted Future Sales based upon: </li></ul><ul><ul><li>“ Naïve” approach based upon continued historical trends, or </li></ul></ul><ul><ul><li>Historical trends adjusted for anticipated changes in operations or environment </li></ul></ul><ul><li>Forecasted Net Profit Margin based upon: </li></ul><ul><ul><li>“ Naïve” approach based upon continued historical trends, or </li></ul></ul><ul><ul><li>Historical trends adjusted for anticipated changes in operations or environment, or </li></ul></ul><ul><ul><li>Earnings forecasts from brokerage houses, Value Line , Forbes , or other sources </li></ul></ul>
  8. 8. Step 1: Forecast Future Sales and Profits (cont’d) <ul><li>Example: Assume last year’s sales were $100 million, revenue growth is estimated at 8% and the net profit margin is expected to be 6%. </li></ul>
  9. 9. Step 2: Forecast Future EPS <ul><li>Forecasted outstanding shares of common stock based upon: </li></ul><ul><ul><li>“ Naïve” approach based upon continued historical tends, or </li></ul></ul><ul><ul><li>Historical trends adjusted for anticipated changes in operations or environment </li></ul></ul><ul><li>Forecasted Earnings Per Share (EPS) based upon: </li></ul>
  10. 10. Step 2: Forecast Future EPS (cont’d) <ul><li>Example: Assume estimated profits are $6.5 million, 2 million shares of common stock are outstanding, and the dividend payout ratio is estimated at 40%. </li></ul>
  11. 11. Step 2: Forecast Future Dividends <ul><li>Forecasted Dividend Payout ratio based upon: </li></ul><ul><ul><li>“Naïve” approach based upon continued historical trends, or </li></ul></ul><ul><ul><li>Historical trends adjusted for anticipated changes in operations or environment </li></ul></ul>
  12. 12. Step 2: Forecast Future Dividends (cont’d) <ul><li>Example: Assume estimated profits are $6.5 million, 2 million shares of common stock are outstanding, and the dividend payout ratio is estimated at 40%. </li></ul>
  13. 13. Step 3: Forecast P/E Ratio <ul><li>Estimated P/E ratio based upon: </li></ul><ul><ul><li>“Average market multiple” of all stocks in the marketplace, or </li></ul></ul><ul><ul><li>“Relative P/E multiple” of individual stocks </li></ul></ul><ul><ul><li>Adjust up or down based upon expectations of economic conditions, general stock market outlook in near term, or anticipated changes in company’s operating results </li></ul></ul>
  14. 14. Step 3: Forecast P/E Ratio <ul><li>Estimated P/E ratio is function of several variables, including: </li></ul><ul><ul><li>Growth rate in earnings </li></ul></ul><ul><ul><li>General state of the market </li></ul></ul><ul><ul><li>Amount of debt in a company’s capital structure </li></ul></ul><ul><ul><li>Current and projected rate of inflation </li></ul></ul><ul><ul><li>Level of dividends </li></ul></ul>
  15. 15. Step 3: Forecast Future Stock Price <ul><li>Example: Assume estimated EPS are $3.25 and the estimated P/E ratio is 17.5 times. </li></ul><ul><li>To estimate the stock price in three years, extend the EPS figure for two more years and repeat the calculations. </li></ul>
  16. 16. Table 8.4 Summary Forecast Statistics, Universal Office Furnishings
  17. 17. Using Stock Valuation <ul><li>Once we have an estimated future stock price, we can compare it to the current market price to see if it may be a good investment candidate: </li></ul><ul><li>current price < estimated price undervalued </li></ul><ul><li>current price = estimated price fairly valued </li></ul><ul><li>current price > estimated price overvalued </li></ul>
  18. 18. The Valuation Process <ul><li>Valuation is a process by which an investor uses risk and return concepts to determine the worth of a security. </li></ul><ul><ul><li>Valuation models help determine what a stock ought to be worth </li></ul></ul><ul><ul><li>If expected rate of return equals or exceeds our target yield, the stock could be a worthwhile investment candidate </li></ul></ul><ul><ul><li>If the intrinsic worth equals or exceeds the current market value, the stock could be a worthwhile investment candidate </li></ul></ul><ul><ul><li>There is no assurance that actual outcome will match expected outcome </li></ul></ul>
  19. 19. Required Rate of Return <ul><li>Required Rate of Return is the return necessary to compensate an investor for the risk involved in an investment. </li></ul><ul><ul><li>Used as a target return to compare forecasted returns on potential investment candidates </li></ul></ul>
  20. 20. Required Rate of Return (cont’d) <ul><li>Example: Assume a company has a beta of 1.30, the risk-free rate is 5.5% and the expected market return is 15%. What is the required rate of return for this investment? </li></ul>
  21. 21. Other Stock Valuation Methods <ul><li>Dividend Valuation Model </li></ul><ul><ul><li>Zero growth </li></ul></ul><ul><ul><li>Constant growth </li></ul></ul><ul><ul><li>Variable growth </li></ul></ul><ul><li>Dividend and Earnings Approach </li></ul><ul><li>Price/Earnings Approach </li></ul><ul><li>Other Price-Relative Approaches </li></ul><ul><ul><li>Price-to-cash-flow ratio </li></ul></ul><ul><ul><li>Price-to-sales ratio </li></ul></ul><ul><ul><li>Price-to-book-value ratio </li></ul></ul>
  22. 22. Dividend Valuation Model: Zero Growth <ul><li>Uses present value to value stock </li></ul><ul><li>Assumes stock value is capitalized value of its annual dividends </li></ul><ul><li>Potential capital gains are really based upon future dividends to be received </li></ul><ul><li>Assumes dividends will not grow over time </li></ul>
  23. 23. Dividend Valuation Model: Constant Growth <ul><li>Uses present value to value stock </li></ul><ul><li>Assumes stock value is capitalized value of its annual dividends </li></ul><ul><li>Assumes dividends will grow at a constant rate over time </li></ul><ul><li>Works best with established companies with history of steady dividend payments </li></ul>
  24. 24. Dividend Valuation Model: Variable Growth <ul><li>Uses present value to value stock </li></ul><ul><li>Assume stock value is capitalized value of its annual dividends </li></ul><ul><li>Allows for variable growth in dividend growth rate </li></ul><ul><li>Most difficult aspect is specifying the appropriate growth rate over an extended period of time </li></ul>
  25. 25. Dividends-and-Earnings Approach <ul><li>Very similar to variable-growth DVM </li></ul><ul><li>Uses present value to value stock </li></ul><ul><li>Assumes stock value is capitalized value of its annual dividends and future sale price </li></ul><ul><li>Works well with companies who pay little or no dividends </li></ul>
  26. 26. Price/Earnings (P/E) Approach <ul><li>Future price is based upon the appropriate P/E ratio and forecasted EPS </li></ul><ul><li>Simple to use and easy to understand </li></ul><ul><li>Widely used in stock valuation </li></ul>
  27. 27. Price-to-Cash-Flow (P/CF) Approach <ul><li>Similar to P/E approach, but substitutes projected cash flow for earnings </li></ul><ul><li>Widely used by investors </li></ul><ul><li>Many consider cash flow to be more accurate than profits to evaluate a stock </li></ul>
  28. 28. Price-to-Sales (P/S) Approach <ul><li>Similar to P/E approach, but substitutes projected sales for earnings </li></ul><ul><li>Useful for companies with no earnings or erratic earnings </li></ul>
  29. 29. Price-to-Book-Value (P/BV) Approach <ul><li>Similar to P/E approach, but substitutes book value for earnings </li></ul>
  30. 30. Chapter 8 Review <ul><li>Learning Goals </li></ul><ul><ul><li>Explain the role that a company’s future plays in stock valuation. </li></ul></ul><ul><ul><li>Develop a forecast of a stock’s cash flow, expected dividends and share price. </li></ul></ul><ul><ul><li>Discuss the concepts of intrinsic value and required rates of return, and note how they are used. </li></ul></ul><ul><ul><li>Determine the underlying value of a stock using various dividend valuation models. </li></ul></ul>
  31. 31. Chapter 8 Review (cont’d) <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Use other types of present-value-based models to derive the value of a stock as well as alternative price-relative procedures. </li></ul></ul><ul><ul><li>Gain a basic appreciation of the procedures used to value different types of stocks, from traditional dividend-paying shares to more growth-oriented stocks. </li></ul></ul>
  32. 32. Chapter 8 Additional Chapter Art
  33. 33. Table 8.2 Average Market P/E Multiples 1977–2006
  34. 34. Table 8.3 Selected Historical Financial Data, Universal Office Furnishings
  35. 35. Table 8.5 Using the Variable-Growth DVM to Value Sweatmore Stock
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