L Pch15


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L Pch15

  1. 1. Investments Chapter 15: Stocks: Valuation and Selection
  2. 2. Dividend Discount Models (DDMs) <ul><li>Models based on the principle that the intrinsic value of an asset is the present value of all its expected future cash flows. </li></ul>
  3. 3. Generalized DDM <ul><li>where E ( DPSt ) is the expected dividend per share paid at the end of Year t, </li></ul><ul><li>and k is the proper discount rate at which the cash flows are discounted. </li></ul>
  4. 4. The Constant Dividend Growth Model: I <ul><li>Also known as the Gordon Growth Model. </li></ul><ul><li>Assumes that a firm’s expected earnings per share grow at a constant growth rate ( g ) and that it pays a constant percentage of its earnings as dividends: </li></ul>
  5. 5. The Constant Dividend Growth Model: II <ul><li>The general DDM equation then reduces to the following simplified valuation equation: </li></ul>
  6. 6. Estimating the Inputs: g <ul><li>1. Historical extrapolation: </li></ul><ul><li>2. Implied values: </li></ul>
  7. 7. Estimating the Inputs: k <ul><li>1. Based on the CAPM: </li></ul><ul><li>2. Implied values: </li></ul>
  8. 8. Super-growth Firms <ul><li>A super-growth firm can increase the growth rate of the EPS and DPS with no change in their dividend policy. </li></ul><ul><li>For the valuation of super-growth firms, the following equation applies: </li></ul>
  9. 9. Multi-stage Growth Models <ul><li>Two-stage growth models </li></ul><ul><li>Firm assumed to first experience super-growth and then normal growth. </li></ul><ul><li>Three-stage growth models </li></ul><ul><li>Firm assumed to evolve through three stages: growth, transition and maturity. </li></ul>
  10. 10. Weaknesses in DDMs <ul><li>1. DDMs do not explain why mispricing occurs or when it will be corrected. </li></ul><ul><li>2. The discount rate may change over time. </li></ul><ul><li>3. DDM results are highly sensitive to the choice of input parameters. </li></ul><ul><li>4. The DDM is forward-looking, while most investors base their estimates on the past. </li></ul><ul><li>5. It’s difficult to assess the performance of the DDM. </li></ul>
  11. 11. The Free Cash Flow Model <ul><li>Values a firm ‘as if’ it distributes the maximum sustainable amount of dividend, this maximum is known as the free cash flow . </li></ul><ul><li>The value of a normal-growth firm can then be calculated as: </li></ul>
  12. 12. Valuation Multiples: I <ul><li>A value driver is a variable that is supposed to measure the intrinsic value of a firm’s equity. </li></ul><ul><li>Multiples are the ratio of the market price of a share, or the market price of a firm, to a value driver. </li></ul>
  13. 13. Valuation Multiples: II <ul><li>The price/earnings (P/E) ratio. </li></ul><ul><li>The dividend yield. </li></ul><ul><li>Tobin’s q. </li></ul>
  14. 14. Security Analysis <ul><li>Three approaches to security analysis: </li></ul><ul><li>1. Firm-level analysis. </li></ul><ul><li>2. Industry analysis. </li></ul><ul><li>3. Macroeconomic analysis. </li></ul>