2. What we need to cover
• Stocks (Equity)
• Legal rights and Privileges of Shareholders
• Types of shares
• Market Price v/s Intrinsic Value
• Discounted Dividend Model
• Constant Growth Model
3. Equity share/stock
• Share means a share in the share capital of a company
and includes stock.
• Equity share is a main source of finance for any
company
• Giving investors the rights to vote, share profits and
claim on assets.
• Various types of equity capital are authorized, issued,
subscribed, paid up, rights, bonus, sweat equity etc.
• The value of equity shares are expressed in terms of
face value or par value, issue price, book value, market
value etc.
• Popularly called stock/ordinary share
4. Legal rights and Privileges of
Shareholders
• Right to share income and assets
• Control of the firm – right to elect the BoD
• Pre-emptive right - privilege offered to existing
shareholders for buying a specified number of
shares of the company's stocks before the stocks
are offered to outsiders for sale
• Voting Right - Common stockholders can attend
the annual general meeting to cast vote or use a
proxy.
5. Types of shares
• Equity/ordinary share – two types
– Equity share with voting rights
– Equity share with differential rights as to dividend, voting
rights or otherwise as prescribed by the central
Government
• Preference share – those shares carry a preferential
right to dividend and repayment
– Cumulative and non-cumulative
– Convertible and non-convertible
– Redeemable and irredeemable
– Participating and non-participating
6. Market price Vs Intrinsic Value
• Market value - Value of a stock that is readily
available from market quotations
• Price in the current market
• Intrinsic value - the actual value of an asset
• Calculated by summing the discounted future
income generated by the asset
• The intrinsic value of a share is the present value
of all future amounts to be received in respect of
the ownership of that share, computed at an
appropriate discount rate
7. SHARE VALUATION MODEL
• Model used to estimate the intrinsic value of a
share - Present Value model.
• The intrinsic value of a share is the present
value of all future amounts to be received in
respect of the ownership of that share,
computed at an appropriate discount rate
8. Equity valuation
Dividend capitalization approach
o Single period valuation
o Multi period valuation
Ratio Approach
o Price earnings ratio
o Price-book value ratio
o Price –sales ratio
9. Dividend capitalization approach/
Discounted dividend techniques
Dividend discount model
Value of an equity share = present value of dividends
expected from its ownership plus the present value
of the sale price expected when equity share is sold
1. Single period valuation/One year holding period
P0 =[ D1/(1+r) ]+ P1 / (1+r)
2. Multiple year holding period
P0 = D1/(1+r)1 +D2/ (1+r)2 +…+Dn/(1+r)n +Pn/ (1+r)n
10. Exercise
• An investor expects to get Rs. 3.5 as dividend
from a share next year and hopes to sell off the
share at Rs. 45 after holding it for 1 year. The
required rate of return is 25%. Compute the
intrinsic value of the share
• An investor expects the share to pay a dividend of
Rs.2 next year, and would sell the share at an
expected price of Rs.21 at the end of the year.. If
the investor’s required rate of return is 15%, how
much should he pay for the share today?
11. Exercise
• An investor expects to get Rs. 3.5, Rs. 4, and
Rs. 4.5 as dividend from a share during the
next three years, and hopes to sell it off at Rs.
75 at the end of the third year. The required
rate of return is 25%. Compute the intrinsic
value of the share
12. Discounted cash flow techniques:
Dividend discount model
• 3. Zero growth model – Assume dividend per
share remains constant year after year
• P0 = D/r
• 4. Constant growth model(Gordon Model)
• Assume dividend per share grows at a
constant rate
• P0 = D1/(r –g)
D1 – dividend at the end of the first year
D1 = D0(1+g), D0 is current dividend
13. Exercise
• A company has declared a dividend of Rs. 2.5
per share for the current year. The company
has been following a policy of enhancing its
dividends by 10% every year and is expected
to continue this policy in the future also. An
investor who is considering the purchase of
the shares of this company has a required rate
of return of 15%. What is the intrinsic value of
the company’s share?
14. • A company paid a dividend of Rs.3.70 in the
previous year. The dividends in the future are
expected to grow perpetually at a rate of 8%.
Find out the share’s price today if the market
capitalizes dividend at 12%?
15. Dividend discount model…….
• Two stage growth model
• Two periods of growth in companies – initial
period of extra ordinary growth and
subsequent constant growth period
P0= v1+v2
• V1= D1/(1+r)1 +D2/ (1+r)2 +…+Dn/(1+r)n
• V2= Dn(1+g)/(r-g)(1+r)n
16. Exercise
• A company paid a dividend of Rs. 1.75 per
share during the current year. It is expected to
pay a dividend of Rs. 2 per share during the
next year. Investor’s forecast a dividend of Rs.
3 and Rs.3.5 per share respectively during the
two subsequent years. After that it is
expected that annual dividends will grow at
10% per year into an indefinite future. If the
investor’s required rate of return is 20%,
compute the intrinsic value of the share
17. Ratio approach
Price earnings ratio (earnings multiplier approach)
Value of a stock
P0 = E1 x P0 /E1
P0 = estimated value, E1 = estimated EPS, P0 /E1 = P/E ratio
P/E ratio = (1-b) /(r –g)
(1-b) = dividend pay out ratio, r = required rate of return, g =
expected growth rate (ROE x retention ratio(b))
Price-book value ratio
PBV ratio = MPS at time t/ BVS at time t
Price –sales ratio
Price/sales
