This document outlines various equity valuation models and ratios. It discusses balance sheet valuation approaches, the dividend discount model including single-period, multi-period, zero growth and constant growth models. It also covers the two-stage growth model, H-model, free cash flow model, earnings multiplier approach, and comparative valuation ratios like P/E, PBV, and PSR. Equity portfolio management strategies and forecasting aggregate stock market returns are also summarized.
STOCKS, SHARES, EQUITY SHARES, PREFERENCE SHARES, BONDS, DEBENTURES, STOCK VALUATION, FEATURES OF COMMON STOCK, DETERMINING COMMON STOCK VALUES, EFFECTIVE MARKETS, etc.
1CHAPTER 7Stocks, Stock Valuation, and Stock Market Equili.docxhyacinthshackley2629
1
CHAPTER 7
Stocks, Stock Valuation, and
Stock Market Equilibrium
2
Topics in Chapter
Features of common stock
Valuing common stock
Preferred stock
Stock market equilibrium
Efficient markets hypothesis
Implications of market efficiency for financial decisions
1
ValueStock = + + +
D1
D2
D∞
(1 + rs )1
(1 + rs)∞
(1 + rs)2
Dividends (Dt)
Market interest rates
Firm’s business risk
Market risk aversion
Firm’s debt/equity mix
Cost of
equity (rs)
Free cash flow
(FCF)
The Big Picture:
The Intrinsic Value of Common Stock
...
For value box in Ch 4 time value FM13.
4
Common Stock: Owners, Directors, and Managers
Represents ownership.
Ownership implies control.
Stockholders elect directors.
Directors hire management.
Since managers are “agents” of shareholders, their goal should be: Maximize stock price.
5
Classified Stock
Classified stock has special provisions.
Could classify existing stock as founders’ shares, with voting rights but dividend restrictions.
New shares might be called “Class A” shares, with voting restrictions but full dividend rights.
6
Tracking Stock
The dividends of tracking stock are tied to a particular division, rather than the company as a whole.
Investors can separately value the divisions.
Its easier to compensate division managers with the tracking stock.
But tracking stock usually has no voting rights, and the financial disclosure for the division is not as regulated as for the company.
7
Different Approaches for Valuing Common Stock
Dividend growth model
Constant growth stocks
Nonconstant growth stocks
Free cash flow method (covered in Chapter 11)
Using the multiples of comparable firms
8
Stock Value = PV of Dividends
What is a constant growth stock?
One whose dividends are expected to grow forever at a constant rate, g.
P0 =
^
(1 + rs)1 (1 + rs)2 (1 + rs)3 (1 + rs)∞
D1 D2 D3 D∞
+
+
+ … +
9
For a constant growth stock:
D1 = D0(1 + g)1
D2 = D0(1 + g)2
Dt = D0(1 + g)t
If g is constant and less than rs, then:
P0 =
^
D0(1 + g)
rs – g
=
D1
rs – g
10
Dividend Growth and PV of Dividends: P0 = ∑(PV of Dt)
$
0.25
Years (t)
Dt = D0(1 + g)t
PV of Dt =
Dt
(1 + r)t
If g > r, P0 = ∞ !
11
What happens if g > rs?
P0 =
^
(1 + rs)1 (1 + rs)2 (1 + rs)∞
D0(1 + g)1 D0(1 + g)2 D0(1 + rs)∞
+
+ … +
(1 + g)t
(1 + rs)t
P0 = ∞
^
> 1, and
So g must be less than rs for the constant growth model to be applicable!!
If g > rs, then
12
Required rate of return: beta = 1.2, rRF = 7%, and RPM = 5%.
rs = rRF + (RPM)bFirm
= 7% + (5%)(1.2)
= 13%.
Use the SML to calculate rs:
13
Projected Dividends
D0 = $2 and constant g = 6%
D1 = D0(1 + g) = $2(1.06) = $2.12
D2 = D1(1 + g) = $2.12(1.06) = $2.2472
D3 = D2(1 + g) = $2.2472(1.06) = $2.3820
11
14
Expected Div.
STOCKS, SHARES, EQUITY SHARES, PREFERENCE SHARES, BONDS, DEBENTURES, STOCK VALUATION, FEATURES OF COMMON STOCK, DETERMINING COMMON STOCK VALUES, EFFECTIVE MARKETS, etc.
1CHAPTER 7Stocks, Stock Valuation, and Stock Market Equili.docxhyacinthshackley2629
1
CHAPTER 7
Stocks, Stock Valuation, and
Stock Market Equilibrium
2
Topics in Chapter
Features of common stock
Valuing common stock
Preferred stock
Stock market equilibrium
Efficient markets hypothesis
Implications of market efficiency for financial decisions
1
ValueStock = + + +
D1
D2
D∞
(1 + rs )1
(1 + rs)∞
(1 + rs)2
Dividends (Dt)
Market interest rates
Firm’s business risk
Market risk aversion
Firm’s debt/equity mix
Cost of
equity (rs)
Free cash flow
(FCF)
The Big Picture:
The Intrinsic Value of Common Stock
...
For value box in Ch 4 time value FM13.
4
Common Stock: Owners, Directors, and Managers
Represents ownership.
Ownership implies control.
Stockholders elect directors.
Directors hire management.
Since managers are “agents” of shareholders, their goal should be: Maximize stock price.
5
Classified Stock
Classified stock has special provisions.
Could classify existing stock as founders’ shares, with voting rights but dividend restrictions.
New shares might be called “Class A” shares, with voting restrictions but full dividend rights.
6
Tracking Stock
The dividends of tracking stock are tied to a particular division, rather than the company as a whole.
Investors can separately value the divisions.
Its easier to compensate division managers with the tracking stock.
But tracking stock usually has no voting rights, and the financial disclosure for the division is not as regulated as for the company.
7
Different Approaches for Valuing Common Stock
Dividend growth model
Constant growth stocks
Nonconstant growth stocks
Free cash flow method (covered in Chapter 11)
Using the multiples of comparable firms
8
Stock Value = PV of Dividends
What is a constant growth stock?
One whose dividends are expected to grow forever at a constant rate, g.
P0 =
^
(1 + rs)1 (1 + rs)2 (1 + rs)3 (1 + rs)∞
D1 D2 D3 D∞
+
+
+ … +
9
For a constant growth stock:
D1 = D0(1 + g)1
D2 = D0(1 + g)2
Dt = D0(1 + g)t
If g is constant and less than rs, then:
P0 =
^
D0(1 + g)
rs – g
=
D1
rs – g
10
Dividend Growth and PV of Dividends: P0 = ∑(PV of Dt)
$
0.25
Years (t)
Dt = D0(1 + g)t
PV of Dt =
Dt
(1 + r)t
If g > r, P0 = ∞ !
11
What happens if g > rs?
P0 =
^
(1 + rs)1 (1 + rs)2 (1 + rs)∞
D0(1 + g)1 D0(1 + g)2 D0(1 + rs)∞
+
+ … +
(1 + g)t
(1 + rs)t
P0 = ∞
^
> 1, and
So g must be less than rs for the constant growth model to be applicable!!
If g > rs, then
12
Required rate of return: beta = 1.2, rRF = 7%, and RPM = 5%.
rs = rRF + (RPM)bFirm
= 7% + (5%)(1.2)
= 13%.
Use the SML to calculate rs:
13
Projected Dividends
D0 = $2 and constant g = 6%
D1 = D0(1 + g) = $2(1.06) = $2.12
D2 = D1(1 + g) = $2.12(1.06) = $2.2472
D3 = D2(1 + g) = $2.2472(1.06) = $2.3820
11
14
Expected Div.
1CHAPTER 6Risk, Return, and the Capital Asset Pricing Model.docxhyacinthshackley2629
1
CHAPTER 6
Risk, Return, and the Capital Asset Pricing Model
2
Topics in Chapter
Basic return concepts
Basic risk concepts
Stand-alone risk
Portfolio (market) risk
Risk and return: CAPM/SML
1
Value = + + +
FCF1
FCF2
FCF∞
(1 + WACC)1
(1 + WACC)∞
(1 + WACC)2
Free cash flow
(FCF)
Market interest rates
Firm’s business risk
Market risk aversion
Firm’s debt/equity mix
Cost of debt
Cost of equity
Weighted average
cost of capital
(WACC)
Net operating
profit after taxes
Required investments
in operating capital
−
=
Determinants of Intrinsic Value:
The Cost of Equity
...
For value box in Ch 4 time value FM13.
4
What are investment returns?
Investment returns measure the financial results of an investment.
Returns may be historical or prospective (anticipated).
Returns can be expressed in:
Dollar terms.
Percentage terms.
5
An investment costs $1,000 and is sold after 1 year for $1,100.
Dollar return:
Percentage return:
$ Received - $ Invested
$1,100 - $1,000 = $100.
$ Return/$ Invested
$100/$1,000 = 0.10 = 10%.
2
6
What is investment risk?
Typically, investment returns are not known with certainty.
Investment risk pertains to the probability of earning a return less than that expected.
The greater the chance of a return far below the expected return, the greater the risk.
2
7
Probability Distribution: Which stock is riskier? Why?
8
Consider the Following
Investment AlternativesEcon.Prob.T-BillAltaRepoAm F.MPBust 0.10 8.0% -22.0% 28.0% 10.0% -13.0%Below avg. 0.20 8.0 -2.0 14.7 -10.0 1.0Avg. 0.40 8.0 20.0 0.0 7.0 15.0Above avg. 0.20 8.0 35.0 -10.0 45.0 29.0Boom 0.10 8.0 50.0 -20.0 30.0 43.0 1.00
9
What is unique about the T-bill return?
The T-bill will return 8% regardless of the state of the economy.
Is the T-bill riskless? Explain.
5
10
Alta Inds. and Repo Men vs. the Economy
Alta Inds. moves with the economy, so it is positively correlated with the economy. This is the typical situation.
Repo Men moves counter to the economy. Such negative correlation is unusual.
7
11
Calculate the expected rate of return on each alternative.
r = expected rate of return.
rAlta = 0.10(-22%) + 0.20(-2%)
+ 0.40(20%) + 0.20(35%)
+ 0.10(50%) = 17.4%.
^
^
n
∑
r =
^
i=1
riPi.
12
Alta has the highest rate of return. Does that make it best?^rAlta 17.4%Market15.0Am. Foam13.8T-bill 8.0Repo Men 1.7
13
What is the standard deviation
of returns for each alternative?
σ = Standard deviation
σ = √ Variance = √ σ2
n
∑
i=1
= √
(ri – r)2 Pi.
^
14
= [(-22 - 17.4)20.10 + (-2 - 17.4)20.20
+ (20 - 17.4)20.40 + (35 - 17.4)20.20
+ (50 - 17.4)20.10]1/2
= 20.0%.
Standard Deviation of Alta Industries
11
15
T-bills = 0.0%.
Alta = 20.0%.
Repo = 13.4%.
Am Foam = 18.
1CHAPTER 6Risk, Return, and the Capital Asset Pricing Model.docxhyacinthshackley2629
1
CHAPTER 6
Risk, Return, and the Capital Asset Pricing Model
2
Topics in Chapter
Basic return concepts
Basic risk concepts
Stand-alone risk
Portfolio (market) risk
Risk and return: CAPM/SML
1
Value = + + +
FCF1
FCF2
FCF∞
(1 + WACC)1
(1 + WACC)∞
(1 + WACC)2
Free cash flow
(FCF)
Market interest rates
Firm’s business risk
Market risk aversion
Firm’s debt/equity mix
Cost of debt
Cost of equity
Weighted average
cost of capital
(WACC)
Net operating
profit after taxes
Required investments
in operating capital
−
=
Determinants of Intrinsic Value:
The Cost of Equity
...
For value box in Ch 4 time value FM13.
4
What are investment returns?
Investment returns measure the financial results of an investment.
Returns may be historical or prospective (anticipated).
Returns can be expressed in:
Dollar terms.
Percentage terms.
5
An investment costs $1,000 and is sold after 1 year for $1,100.
Dollar return:
Percentage return:
$ Received - $ Invested
$1,100 - $1,000 = $100.
$ Return/$ Invested
$100/$1,000 = 0.10 = 10%.
2
6
What is investment risk?
Typically, investment returns are not known with certainty.
Investment risk pertains to the probability of earning a return less than that expected.
The greater the chance of a return far below the expected return, the greater the risk.
2
7
Probability Distribution: Which stock is riskier? Why?
8
Consider the Following
Investment AlternativesEcon.Prob.T-BillAltaRepoAm F.MPBust 0.10 8.0% -22.0% 28.0% 10.0% -13.0%Below avg. 0.20 8.0 -2.0 14.7 -10.0 1.0Avg. 0.40 8.0 20.0 0.0 7.0 15.0Above avg. 0.20 8.0 35.0 -10.0 45.0 29.0Boom 0.10 8.0 50.0 -20.0 30.0 43.0 1.00
9
What is unique about the T-bill return?
The T-bill will return 8% regardless of the state of the economy.
Is the T-bill riskless? Explain.
5
10
Alta Inds. and Repo Men vs. the Economy
Alta Inds. moves with the economy, so it is positively correlated with the economy. This is the typical situation.
Repo Men moves counter to the economy. Such negative correlation is unusual.
7
11
Calculate the expected rate of return on each alternative.
r = expected rate of return.
rAlta = 0.10(-22%) + 0.20(-2%)
+ 0.40(20%) + 0.20(35%)
+ 0.10(50%) = 17.4%.
^
^
n
∑
r =
^
i=1
riPi.
12
Alta has the highest rate of return. Does that make it best?^rAlta 17.4%Market15.0Am. Foam13.8T-bill 8.0Repo Men 1.7
13
What is the standard deviation
of returns for each alternative?
σ = Standard deviation
σ = √ Variance = √ σ2
n
∑
i=1
= √
(ri – r)2 Pi.
^
14
= [(-22 - 17.4)20.10 + (-2 - 17.4)20.20
+ (20 - 17.4)20.40 + (35 - 17.4)20.20
+ (50 - 17.4)20.10]1/2
= 20.0%.
Standard Deviation of Alta Industries
11
15
T-bills = 0.0%.
Alta = 20.0%.
Repo = 13.4%.
Am Foam = 18.
Unit 8 - Information and Communication Technology (Paper I).pdfThiyagu K
This slides describes the basic concepts of ICT, basics of Email, Emerging Technology and Digital Initiatives in Education. This presentations aligns with the UGC Paper I syllabus.
Operation “Blue Star” is the only event in the history of Independent India where the state went into war with its own people. Even after about 40 years it is not clear if it was culmination of states anger over people of the region, a political game of power or start of dictatorial chapter in the democratic setup.
The people of Punjab felt alienated from main stream due to denial of their just demands during a long democratic struggle since independence. As it happen all over the word, it led to militant struggle with great loss of lives of military, police and civilian personnel. Killing of Indira Gandhi and massacre of innocent Sikhs in Delhi and other India cities was also associated with this movement.
2024.06.01 Introducing a competency framework for languag learning materials ...Sandy Millin
http://sandymillin.wordpress.com/iateflwebinar2024
Published classroom materials form the basis of syllabuses, drive teacher professional development, and have a potentially huge influence on learners, teachers and education systems. All teachers also create their own materials, whether a few sentences on a blackboard, a highly-structured fully-realised online course, or anything in between. Despite this, the knowledge and skills needed to create effective language learning materials are rarely part of teacher training, and are mostly learnt by trial and error.
Knowledge and skills frameworks, generally called competency frameworks, for ELT teachers, trainers and managers have existed for a few years now. However, until I created one for my MA dissertation, there wasn’t one drawing together what we need to know and do to be able to effectively produce language learning materials.
This webinar will introduce you to my framework, highlighting the key competencies I identified from my research. It will also show how anybody involved in language teaching (any language, not just English!), teacher training, managing schools or developing language learning materials can benefit from using the framework.
Instructions for Submissions thorugh G- Classroom.pptxJheel Barad
This presentation provides a briefing on how to upload submissions and documents in Google Classroom. It was prepared as part of an orientation for new Sainik School in-service teacher trainees. As a training officer, my goal is to ensure that you are comfortable and proficient with this essential tool for managing assignments and fostering student engagement.
Embracing GenAI - A Strategic ImperativePeter Windle
Artificial Intelligence (AI) technologies such as Generative AI, Image Generators and Large Language Models have had a dramatic impact on teaching, learning and assessment over the past 18 months. The most immediate threat AI posed was to Academic Integrity with Higher Education Institutes (HEIs) focusing their efforts on combating the use of GenAI in assessment. Guidelines were developed for staff and students, policies put in place too. Innovative educators have forged paths in the use of Generative AI for teaching, learning and assessments leading to pockets of transformation springing up across HEIs, often with little or no top-down guidance, support or direction.
This Gasta posits a strategic approach to integrating AI into HEIs to prepare staff, students and the curriculum for an evolving world and workplace. We will highlight the advantages of working with these technologies beyond the realm of teaching, learning and assessment by considering prompt engineering skills, industry impact, curriculum changes, and the need for staff upskilling. In contrast, not engaging strategically with Generative AI poses risks, including falling behind peers, missed opportunities and failing to ensure our graduates remain employable. The rapid evolution of AI technologies necessitates a proactive and strategic approach if we are to remain relevant.
Macroeconomics- Movie Location
This will be used as part of your Personal Professional Portfolio once graded.
Objective:
Prepare a presentation or a paper using research, basic comparative analysis, data organization and application of economic information. You will make an informed assessment of an economic climate outside of the United States to accomplish an entertainment industry objective.
Synthetic Fiber Construction in lab .pptxPavel ( NSTU)
Synthetic fiber production is a fascinating and complex field that blends chemistry, engineering, and environmental science. By understanding these aspects, students can gain a comprehensive view of synthetic fiber production, its impact on society and the environment, and the potential for future innovations. Synthetic fibers play a crucial role in modern society, impacting various aspects of daily life, industry, and the environment. ynthetic fibers are integral to modern life, offering a range of benefits from cost-effectiveness and versatility to innovative applications and performance characteristics. While they pose environmental challenges, ongoing research and development aim to create more sustainable and eco-friendly alternatives. Understanding the importance of synthetic fibers helps in appreciating their role in the economy, industry, and daily life, while also emphasizing the need for sustainable practices and innovation.
How to Make a Field invisible in Odoo 17Celine George
It is possible to hide or invisible some fields in odoo. Commonly using “invisible” attribute in the field definition to invisible the fields. This slide will show how to make a field invisible in odoo 17.
A Strategic Approach: GenAI in EducationPeter Windle
Artificial Intelligence (AI) technologies such as Generative AI, Image Generators and Large Language Models have had a dramatic impact on teaching, learning and assessment over the past 18 months. The most immediate threat AI posed was to Academic Integrity with Higher Education Institutes (HEIs) focusing their efforts on combating the use of GenAI in assessment. Guidelines were developed for staff and students, policies put in place too. Innovative educators have forged paths in the use of Generative AI for teaching, learning and assessments leading to pockets of transformation springing up across HEIs, often with little or no top-down guidance, support or direction.
This Gasta posits a strategic approach to integrating AI into HEIs to prepare staff, students and the curriculum for an evolving world and workplace. We will highlight the advantages of working with these technologies beyond the realm of teaching, learning and assessment by considering prompt engineering skills, industry impact, curriculum changes, and the need for staff upskilling. In contrast, not engaging strategically with Generative AI poses risks, including falling behind peers, missed opportunities and failing to ensure our graduates remain employable. The rapid evolution of AI technologies necessitates a proactive and strategic approach if we are to remain relevant.
Read| The latest issue of The Challenger is here! We are thrilled to announce that our school paper has qualified for the NATIONAL SCHOOLS PRESS CONFERENCE (NSPC) 2024. Thank you for your unwavering support and trust. Dive into the stories that made us stand out!
4. Dividend Discount Model
• SINGLE PERIOD VALUATION MODEL
D1 P1
P0 = +
(1+r) (1+r)
• MULTI - PERIOD VALUATION MODEL
Dt
P0 =
t=1 (1+r)t
• ZERO GROWTH MODEL
D
P0 =
r
• CONSTANT GROWTH MODEL
D1
P0 =
r - g
5. Two-Stage Growth Model
1 - 1+g1
n
1+r Pn
P0 = D1 +
r - g1 (1+r)n
WHERE
Pn D1 (1+g1)n-1 (1+g2) 1
=
(1+r)n r - g2 (1+r)n
6. Two-Stage Growth Model: Example
EXAMPLE THE CURRENT DIVIDEND ON AN EQUITY SHARE OF
VERTIGO LIMITED IS RS.2.00. VERTIGO IS EXPECTED TO ENJOY AN
ABOVE-NORMAL GROWTH RATE OF 20 PERCENT FOR A PERIOD OF 6
YEARS. THEREAFTER THE GROWTH RATE WILL FALL AND STABILISE
AT 10 PERCENT. EQUITY INVESTORS REQUIRE A RETURN OF 15
PERCENT. WHAT IS THE INTRINSIC VALUE OF THE EQUITY SHARE OF
VERTIGO ?
THE INPUTS REQUIRED FOR APPLYING THE TWO-STAGE MODEL ARE :
g1 = 20 PERCENT
g2 = 10 PERCENT
n = 6 YEARS
r = 15 YEARS
D1 = D0 (1+g1) = RS.2(1.20) = 2.40
PLUGGING THESE INPUTS IN THE TWO-STAGE MODEL, WE GET THE
INTRINSIC VALUE ESTIMATE AS FOLLOWS :
1.20 6
1 -
1.15 2.40 (1.20)5
(1.10) 1
P0 = 2.40 +
.15 - .20 .15 - .10 (1.15)6
1 - 1.291 2.40 (2.488)(1.10)
= 2.40 + [0.497]
-0.05 .05
= 13.968 + 65.289
= RS.79.597
7. H Model
ga
gn
H 2H
D0
PO = [(1+gn) + H (ga + gn)]
r - gn
D0 (1+gn) D0 H (ga + gn)
= +
r - gn r - gn
VALUE BASED PREMIUM DUE TO
ON NORMAL ABNORMAL GROWH
GROWTH RATE RATE
8. Illustration: H Ltd
D0 = 1 ga = 25% H = 5
gn = 15% r = 18%
1 (1.15) 1 x 5(.25 - .15)
P0 = +
0.18 - 0.15 0.18 - 0.15
= 38.33 + 16.67 = 55.00
IF E = 2 P/E = 27.5
9. Impact Of Growth On Price, Returns, and P/E Ratio
PRICE DIVIDEND CAPITAL PRICE
D1 YIELD GAINS EARNINGS
PO = YIELD RATIO
r - g (D1 / PO) (P1 - PO) / PO (P / E)
RS. 2.00
LOW GROWTH FIRM PO = = RS.13.33 15.0% 5.0% 4.44
0.20 - 0.05
RS. 2.00
NORMALGROWTH PO = = RS.20.00 10.0% 10.0% 6.67
FIRM 0.20 - 0.10
RS. 2.00
SUPERNORMAL PO = = RS.40.00 5.0% 15.0% 13.33
GROWTH FIRM 0.20 - 0.15
10. Free Cash Flow Model
The enterprise value (EV) according to the free cash flow model is:
EV= FCF1 + FCF2 +…+ FCFH + VH
(1+WACC) (1+WACC)2 (1+WACC)H (1+WACC)H
Present value of the FCF during the
explicit forecast period
Present value of horizon
value
11. Earnings Multiplier Approach
P0 = m E1
DETERMINANTS OF m (P / E)
D1
P0 =
r - g
E1 (1 - b)
=
r - ROE x b
(1 - b)
P0 / E1 =
r - ROE x b
12. CROSS -SECTION REGRESSION ANALYSIS
P / E = 8.2 + 1.5g + 6.7b - .2
g = GROWTH RATE FOR ‘NORMALIZED’ EPS
b = PAYOUT RATIO
= STD. DEV .. OF % EPS CHANGE
• EVERY CONCEIVABLE VARIABLE & COMBINATION OF
VAIRABLES .. TRIED..
• ALMOST .. ALL … THESE MODELS .. HIGHLY SUCCESSFUL ..
EXPLAINING STOCK PRICES .. AT A POINT .. TIME, BUT LESS
SUCCESSFUL … IN SELECTING APPROPRIATE .. STOCKS .. BUY ..
SELL.
• WHY
1. MARKET TASTES CHANGE
• WEIGHTS CHANGE
2. INPUT VALUES CHANGE OVER TIME
• DIV … & GROWTH IN EARNINGS
3. THERE ARE FIRM EFFECTS NOT CAPTURED BY THE MODEL
13. P / E Benchmark
Rules Of Thumb
• GROWTH RATE IN EARNINGS
10% 15% 20% 25% 35%
1 1
• = 8.33
NOMINAL INTEREST RATE .12
1
= 5.00
.20
1 1
• = 25
REAL RETURN .04
1
= 16.67
.06
0.5 PAYOUT RATIO
• = 16.67
.18 - .15 REQ. RET - GR. RATE
14. Growth And P / E Multiple
CASE A : NO GROWTH CASE B : 10 PERCENT GROWTH
YEAR 0 YEAR 1 YEAR 0 YEAR 1
TOTALASSETS 100 100 100 110
NET WORTH 100 100 100 110
SALES 100 100 100 110
PROFIT AFTER
TAX 20 20 20 22
DIVIDENDS 20 20 10 11
RETAINED
EARNINGS - - 10 11
CASE A CASE B
NO GROWTH GROWTH
DISCOUNT DISCOUNT DISCOUNT DISCOUNT DISCOUNT DISCOUNT
RATE: 15% RATE: 20% RATE: 25% RATE: 15% RATE: 20% RATE: 25%
VALUE 20 / 0.15 20 / 0.20 20 / 0.25 10 / (0.15 10 / (0.20 10 / (0.25
- 0.10) - 0.10) - 0.10)
= 133.3 = 100 = 80 = 200 = 100 = 66.7
PRICE- 133.3 / 20 100 / 20 80 / 20 200 /20 100 / 20 66.7 / 20
EARNINGS = 6.67 = 5.0 = 4.0 = 10.0 = 5.0 = 3.33
MULTIPLE
15. E / P, Expected Return, And Growth
1 2
……...
E1 = D1 E2 = D2
= 15 = 15
15
r = 15% P0 = = 100
0.15
INVESTMENT .. RS. 15 PER SHARE IN YEAR 1 … EARNS 15%
2.25
NPV PER SHARE = - 15 + = 0
0.15
RATE OF INCREMENTAL PROJECT'S IMPACT ON SHARE PRICE E1/P0 r
RETURN CASH FLOW NPV IN SHARE PRICE IN YEAR 0,
YEAR 1 IN YEAR 0 P0
0.05 0.75 -10 -8.70 91.30 0.164 0.15
0.10 1.50 -5 -4.35 95.65 0.157 0.15
0.15 2.25 0 0 0 0.15 0.15
0.20 3.00 5 4.35 104.35 0.144 0.15
0.25 3.75 10 8.70 108.70 0.138 0.15
16. IN GENERAL, WE CAN THINK OF THE STOCK PRICE AS THE
CAPITALISED VALUE OF THE EARNINGS UNDER THE ASSUMPTION OF
NO GROWTH PLUS THE PRESENT VALUE OF GROWTH OPPORTUNITIES
(PVGO).
E1
P0 = + PVGO
r
MANIPULATING THIS A BIT, WE GET
E1 PVGO
= r 1 -
P0 P0
FROM THIS EQUATION, IT IS CLEAR THAT :
EARNINGS-PRICE RATIO IS EQUAL TO r WHEN PVGO IS ZERO.
EARNINGS-PRICE RATIO IS LESS THAN r WHEN PVGO IS
POSITIVE.
EARNINGS-PRICE RATIO IS MORE THAN r WHEN PVGO IS
NEGATIVE.
17. Price To Book Value Ratio (PBV Ratio)
Market price per share at time t
PBV ratio =
Book value per share at time t
The PBV ratio has always drawn the attention of investors.
During the 1990s Fama and others suggested that the PBV
ratio explained to a significant extent the returns from
stocks.
18. Determinants Of The PBV Ratio
D1
P0 =
r – g
D1 = E1 (1 – b) = E0 (1 + g) (1 – b)
E0 (1 + g) (1 – b)
r – g
E0 = BV0 x ROE
BV0 (ROE) (1 + g) (1 – b)
r – g
P0 ROE (1 + g) (1 – b)
BV0 r - g
P0 =
P0 =
PBV ratio = =
19. Price To Sales Ratio (PSR Ratios)
• In recent years PSR has received a lot of attention as a
valuation tool. The PSR is calculated by dividing the
current market value of equity capital by annual sales of
the firm.
• Portfolios of low PSR stocks tend to outperform
portfolios of high PSR stocks.
• It makes more sense to look at PSR/Net profit margin as
net profit margin is a key driver of PSR.
21. Companion Variables and Modified Multiples
Let us look at the equations for P/E ratio, PBV ratio, and PS
ratio.
P/E = (1 - b)
r – g
PBV = ROE (1 + g) (1 – b)
(r – g)
PS = NPM (1 + g) (1 – b)
r - g
Looking at these equations, we find that there is one variable that
dominates when it comes to explaining each multiple – it is g for
P/E, ROE for PBV, and NPM for PS. This variable – the
dominant explanatory variable – is called the companion
variable.
22. Taking into account the importance of the companion variable,
investment practitioners often use modified multiples which are
defined below.
• P/E to growth multiple, referred to as PEG : P/E
g
• PBV to ROE, referred to as value ratio : PBV
ROE
• PS to NPM, referred to as PSM : PS
Net profit margin
23. Sum of the Parts Method
Many companies have subsidiaries or associate companies in which they
have significant equity stakes that usually range between 25 percent and
100 percent. To ascertain the intrinsic value per share of such companies
the sum of the parts (SOTP) method of valuation is commonly employed.
The SOTP method involves the following steps:
1. Determine the value per share attributable to the core business. One way to
do is to calculate the earnings per share from the core business and apply a
suitable multiple to it.
2. Find the value per share for each of the listed subsidiaries. In computing
this value a discount factor of 15 to 20 percent is generally applied to the
observed market value of the equity stake in the listed subsidiary.
3. Assess the value per share for each of the unlisted subsidiaries. To do this,
the analyst has to first estimate the market value using an earnings multiple
or some other basis as there is no observed market value and then apply a
a discount factor of 15 to 25 percent to the same.
4. Add the per share values for the core business, for listed subsidiaries, and
for unlisted subsidiaries, to get the total value per share.
24. Equity Portfolio Management
PASSIVE STRATEGY
• BUY AND HOLD STRATEGY
• INDEXING STRATEGY
ACTIVE STRATEGY
• MARKET TIMING
• SECTOR ROTATION
• SECURITY SELECTION
• USE OF A SPECIALISED CONCEPT
25. Forecasting The Aggregate Stock Market Return
Stock market returns are determined by an interaction of two
factors : investment returns and speculative returns.
• In formal terms :
SMRn = [DYn + EGn] + [(PEn / PE0)1/n – 1]
Investment return Speculative return
where : SMRn = annual stock market return over a period of n years
DYn = annual dividend yield over a period of n years
EGn = annual earnings growth over a period of n years
PEn = price-earnings ratio at the end of n years
PE0 = price-earnings ratio at the beginning of n years.
26. Illustration
Suppose you want to forecast the annual return from the stock
market over the next five years (n is equal to 5). You come up with
the following estimates. DY5 = 0.025 (2.5 percent), EG5 = 0.125 (12.5
percent), and PE5 = 18. The current PE ratio, PEo, is 15. The forecast
of the annual return from the stock market is determined as follows:
SMR5 = [0.025 + 0.125] + [(18/15)1/5 – 1]
= [0.15] + [0.037]
= 15 percent + 3.7 percent = 18.7 percent
15 percent represents the investment return and 3.7 percent
represents the speculative return.
27. SUMMING UP
• While the basic principles of valuation are the same for fixed
income securities as well as equity shares, the factors of growth
and risk create greater complexity in the case of equity shares.
• Three valuation measures derived from the balance sheet are:
book value, liquidation value, and replacement cost.
• According to the dividend discount model, the value of an equity
share is equal to the present value of dividends expected from its
ownership.
• If the dividend per share grows at a constant rate, the value of the
share is : P0 = D1/ (r – g)
• A widely practised approach to valuation is the P/E ratio or
earnings multiplier approach. The value of a stock, under this
approach, is estimated as follows:
P0 = E1 x P0/E1
28. • In general, we can think of the stock price as the capitalised value
of the earnings under the assumption of no growth plus the
present value of growth opportunities (PVGo)
E1
P0 = + PVGO
r
• Apart from the price-earnings ratio, price to book value (PBV)
ratio and price to sales (PSR) ratio are two other widely used
comparative valuation ratios
• Two broad approaches are followed in managing an equity
portfolio : passive strategy and active strategy.
• Stock market returns are determined by an interaction of two
factors : investement returns and speculative returns.