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Valuation

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Valuation

1. 1. Basic Valuation Concepts <ul><li>Dividend valuation models </li></ul><ul><ul><li>Constant growth </li></ul></ul><ul><ul><li>Non-constant growth </li></ul></ul><ul><ul><li>Finite/infinite holding period </li></ul></ul><ul><li>Earnings valuation models </li></ul><ul><ul><li>P/E Ratio based model </li></ul></ul><ul><ul><li>Dividend and Earnings model </li></ul></ul><ul><li>Other Valuation models </li></ul><ul><ul><li>Price to Sales </li></ul></ul><ul><ul><li>Price to Dividends </li></ul></ul><ul><ul><li>Price to Earnings </li></ul></ul><ul><ul><li>Price to Cash flow </li></ul></ul><ul><ul><li>Price to Book Value </li></ul></ul>
2. 2. 1. General Dividend Models The value of a share of stock is equal to the present value of an expected stream of future dividends. P 0 = Where P 0 = Present value of the stock price D i = Dividend for each year K e = Required rate of return (discount rate) Model assumes that the investor can determine the dividend for each period and the required rate of return. D 1 (1+K e ) 1 D 2 (1+K e ) 2 + D 3 (1+K e ) 3 + D n (1+K e ) n +. . +
3. 3. Constant Growth Model For extremely long time (infinite holding period) periods, this formula reduces to if following conditions are met. 1. g is constant 2. K e > g P 0 = + D 0 (1+g) 3 (1+K e ) 3 D 0 (1+g) 2 (1+K e ) 2 + D 0 (1+g) n (1+K e ) n + ... + D 0 (1+g) 1 (1+K e ) 1 P 0 = D 1 (K e - g)
4. 4. Required Return K e = Required rate of return R F = Risk-free rate b = Beta Coefficient K M = Expected return for common stocks in the market (K M - R F ) = Equity risk premium (ERP)
5. 6. A Nonconstant Growth Model <ul><li>1. Divide time period into intervals of constant dividend growth </li></ul><ul><li>2. Calculate the dividend at the beginning of each period </li></ul><ul><li>3. Calculate the Present Value of each interval of constant growth </li></ul><ul><li>4. Price = Sum of the PVs </li></ul>
6. 7. Figure 7-1. JAYCAR Growth Pattern. Dividends per share 20% (years 1-10) 8% (years 11 to infinity) 1 5 10 15 20 25 30 35 40 45
7. 8. Non-constant growth illustration P 10 = D 11 / (K e - g) Dividend Year 11 = Div 10 x (1+ growth rate) = 5.15 ( 1.08) = 5.56 P 10 = 5.56 / (12% - 8% ) = 5.56 / .04 = \$139 Discount to Present: \$139 / .322 = \$44.76 P 0 = \$12.42 Growth pattern first ten years JAYCAR's + \$44.76 = \$57.18
8. 9. 2. Combined Earnings and Dividend Model <ul><li>The value of common stock can be viewed as a dividend stream plus a market price at the end of the dividend stream. </li></ul><ul><li>Earnings-per-share and dividends-per-share are estimated for some period. </li></ul><ul><li>Ending stock price estimated by using long-term PE ratio. </li></ul><ul><li>Stock Price = (Present value of dividend flow) + Present value of stock price </li></ul>
9. 10. Price Earnings Ratio <ul><li>It indicates the price that investors are willing to pay for a firm’s earnings. </li></ul><ul><li>Published P/E ratios based on today’s price divided by the latest 12-month earnings. </li></ul><ul><li>P/E ratios can be a proxy for risk. The higher the P/E ratio relative to the market P/E ratio, the higher the risk. </li></ul>
10. 11. Price Earnings Ratio <ul><li>P/E ratios vary across industries. </li></ul><ul><li>P/E ratios are also influenced by the political and economic conditions, management abilities and quality of earnings. </li></ul>
11. 14. Calculating Value based on relative P/E