Equity Markets                                                                                   Common Stock

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U. S. Stock Markets                                                      World Stock Markets
           Major U. S. Stock ...
Payouts                                          The “Constant Growth” Formula
                                           ...
Constant Dividends:                                                          Constant Growth:
               RJR Nabisco P...
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Microsoft PowerPoint - stockmarkets

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Microsoft PowerPoint - stockmarkets

  1. 1. Equity Markets Common Stock l Stockholders are owners of the firm. Investments: F303 l Stockholders are “residual” claimants. l Stockholders have the right to: Kelley School of Business, Indiana » vote at company meetings University » dividends and other distributions » sell their shares l Stockholders benefit in two ways: » Dividends – periodic payments Professor Christian Lundblad » capital gains – appreciation in value l Stock is typically issued by public corporations to finance investments Copyright  Campbell Harvey and Christian Lundblad. All rights reserved. 1 2 Transactions Involving Stocks Stock Market Indices l Buy l Short Sell l Stock Market Indices: Average Return Savings motive Sell stock without first owning it. » of equities in particular regions (geographical) Expect stock to Borrow stock from your broker appreciate in value with the promise to repay it at » Of market segments (i.e. small companies, value stocks, some later date. technology, etc.) Long position Sell the borrowed stock. Construction: l Sell ∑ j= N Liquidity needs Repurchase it at a later date to R Index = j =1 w jR jt Expect stock to decline repay your broker. in value Responsible for all dividends and » Equally weighted: w1=w2=…=wN=1/N other distributions while short the – Return on a portfolio with $1 in each stock stock. » Value weighted: wj= Proportion of market capitalization – Return on a portfolio where more is invested in larger companies 3 4
  2. 2. U. S. Stock Markets World Stock Markets Major U. S. Stock Exchanges l New York Stock Exchange (NYSE) l American Stock Exchange (AMEX) l Over-The-Counter (OTC) l Johannesburg l New York l Mexico » National Association of Securities Dealers (NASDAQ) l Sydney l Tokyo l Canada U. S. Stock Market Indices (August 27, 2002) l London l Brussels l Stockholm Value Net Chg Pct Chg l Amsterdam l Frankfurt l Hong Kong INDU DOW JONES INDUS. AVG 8919.01 46.05 0.52 l Paris l Singapore l Switzerland SPX S&P 500 INDEX 947.95 7.09 0.75 CCMP NASDAQ COMB COMPOSITE IX 1391.74 11.12 0.81 Other Indices l NYSE Composite l Russell 2000 l Wilshire 5000 l Value Line 5 6 Stock Valuation Why short-termists are long-termists Shareholders require a rate of return k for buying a share. They buy for P0 and sell after one year for P1 and receive dividends D1: l The price an investor is willing to pay for a share of stock depends upon: D1 + P1 » Magnitude and timing of expected future dividends. P0 = 1+ k » Risk of the stock. The next buyer also sells after one year: D 2 + P2 D D + P2 The stock’s discount rate, k, is the rate of return investors can P1 = ⇒ P0 = 1 + 2 l 1+ k 1 + k (1 + k )2 expect to earn on securities with similar risk. The same holds for P2. Continuing gives: l Where are the capital gains? D1 D2 D3 P0 = + + + ... 1 + k (1 + k )2 (1 + k )3 Share price = PV of dividends 7 8
  3. 3. Payouts The “Constant Growth” Formula Assumption: Dividends grow at a constant rate g for ever: l Holders of stock receive payouts in two forms: D2 = D1 (1 + g ) , Dt = Dt −1 (1 + g ) = ... = D1 (1 + g ) t −1 = D0 (1 + g ) t » Dividend payouts » Capital gains (stock appreciation P1-P0) Then: D (1 + g ) t −1 D1 D1 (1 + g ) D1 D 1 P1 − P 0 P0 = + + ... + 1 + ... = k = P0 + P0 1 + k (1 + k ) 2 (1 + k )t k−g Prospective Dividend per Share » Capital Gain reflects expected growth in future dividend Share Price = Required return - growth rate l Issues: » constant growth » g<k 9 10 Simplifying the Dividend Discount Constant Dividends: An Example Model l Constant Dividends l Consider a company that pays a dividend of: g = 0 ⇒ D1 = D2 = ... = D $3 per share in bad years (Probability = 50%) $15 per share in good years (Probability = 50%) Then the pricing relation simplifies to: » Required rate of return is 18% » What is the share price? D D P0 = ⇒k = E( Div ) = 0.5 * $3 + 0.5 * $15 = $9 k P0 $9 P0 = = $50 » Stock similar to perpetuity 0.18 l If dividends are constant, then we have: Required return on equity = Dividend yield 11 12
  4. 4. Constant Dividends: Constant Growth: RJR Nabisco Preferred Stock Duke Power Common Stock l RJR Nabisco has stock outstanding l Duke Power currently pays a dividend of $2.04 per share. » annual dividend of $2.50 per share. » Duke Power expects its profits and dividends to grow at about » Securities with similar risk are expected to return 9.6% 7% per year. – what is the price of the preferred stock? » Stockholders require a 12% rate of return – what is the market price of Duke Power’s common stock? D $2.50 P0 = = = $26.04 P0 = (1 + g ) D0 k 0.096 k−g 2.04(1.07) P0 = = $43.66 0.12 − 0.07 13 14 Valuation with Growing Dividends Valuation of GM An Example: Valuation of GM l Generally, companies have growing dividends on stocks, hence l Alternative valuations: apply general formula: Return/Growth 3% 4% 4.50% 5% 6% 7% D 1 7% 34.23 45.64 54.77 68.47 136.93 - P0 = 8% 27.39 34.23 39.12 45.64 68.47 136.93 k − g 9% 22.82 27.39 30.43 34.23 45.64 68.47 l Consider data for GM: 10% 19.56 22.82 24.90 27.39 34.23 45.64 » Number of shares: 855,820 11% 17.12 19.56 21.07 22.82 27.39 34.23 12% 15.21 17.12 18.26 19.56 22.82 27.39 » Market capitalization $42.051bn » Historic dividend $1.50 per share Example: » Your forecast: $1.60 855,820,000*$1.60=$1.37bn – What valuation do you obtain for GM, depending on g and k? D1997 $1.37bn MCAPGM = = $34 .23bn k GM − g GM 0.09 − 0.05 15 16

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