1. Stock Valuation Adam Yoder Misa Ngo

2. Valuation methods  Discounted Cash Flow: Dividends  Present Value of Growth Opportunities  P/E ratio: Price/ Earnings  PEG ratio: PE/ Growth

3. Discounted Cash Flow Model  Formulas:

4. DCF example  Corp A:  Earnings/shr.=$1  Book equity/shr.=$10  Dividend/shr.=$0.50  ROE= EPS/ book =10%  Plowback ratio= RES / EPS=.5  g= ROE * Plowback ratio = 0.1 * 0.5 = 5%  r= rf + b(rm-rf) = 0.05 + 0.75(0.1 - 0.05) = 8.75%

5. DCF Practice Question  Corp. B:  Earnings/shr.=$3  Book equity/shr.=$15  ROE is 3/15 = 20%  Dividend/shr.=$1.75  Risk free rate = 5%  Beta on this stock is 1.25  S&P market return is 10%  g= ROE * Plowback ratio = 0.2 *.416 = 8.3%  r= rf + b(rm-rf) = 0.05 + 01.25(0.1 - 0.05) = 11.25%

6. Present Value of Growth Opportunities (PVGO) - Net present value of a firm’s future investments EPS 1 /r: No-growth capitalized value per share (EPS 1 =DIV 1, P 0 =DIV 1 /r)

7. Present Value of Growth Opportunities (PVGO) Example ROE =.2 Payout ratio =.6, Plowback ratio =.4 EPS 1 = $5.00, DIV 1 = $3.00, r = 15% Find PVGO? P 0 = DIV 1 /(r-g) P 0 = EPS 1 /r + PVGO

8. Present Value of Growth Opportunities (PVGO) Example g = ROE x Plowback ratio =.2 x.4 =.8 (8%) P 0 = DIV 1 /(r-g) = 3/(.15-.08) = $42.86 No-growth value = EPS 1 /r = 5/.15 = 33.33 PVGO = P 0 – EPS 1 /r = $42.86-$33.33 = $9.52

9. Price/Earnings Ratio (P/E)  Amount investors are willing to pay for each dollar of earnings  Higher P/E may indicate high growth potential of the firm  Current stock price/annual EPS d: payout percentage (constant) EPS 1 : next year EPS r: required rate of return g: dividend growth rate

10. Price/Earnings Ratio (P/E) Price of a stock paying dividend D1 at a constant growth rate g Assume the firm pays out a constant percentage d of its earnings E1 Divide both sides by E1

11. Price/Earnings Ratio (P/E)  Example ROE=.16 d =.7 r= 16% Find P/E ratio? P 0 /EPS 1 =d/(r-g)

12. Price/Earnings Ratio  Example g= ROEx Plowback Ratio = ROEx(1-d) =.16x(1-.7) =.048 =.16x(1-.7) =.048 P 0 /EPS 1 = d/(r-g) =.7/(.16-.048) = 6.25

13. PEG Ratio  Used by many analysts to determine a valuation when a stock has little or no dividend and high growth prospects.  Formulas: PEG = PE / G P 0 = g * PEG * EPS P 0 = g * PEG * EPS  Traditional thought is a PEG = 1 is fairly valued  Company A:  $2 EPS  Estimated growth of 15% for next 5 yrs.  Fair value is $30 per share.

14. PEG Ratio  Recently the PEG ratios have increased significantly due to lower discounting rates in the T-bills.  The current S&P PEG ratio is around 1.5  $2 EPS  Estimated growth of 15% for next 5 yrs.  Fair value is $45 per share.

15. PEG Practice Question  Company B:  $3 EPS  20% growth over next 5 years  1.4 Industry average PEG  Formula: P 0 = g * PEG * EPS  P 0 = 20 * 1.4 * 3 = $84

16. Questions?