Chapter 9 Valuing Stocks

9-2 Stock Prices, Returns, and the Investment Horizon Common Stock - Ownership shares in a publicly held corporation. What does ownership of a common stock entitle you to? –Attend and vote at shareholders’ meetings; –Receive dividend; –Sell the stock.

9-3 Valuing Common Stocks Expected Return - The percentage yield that an investor forecasts from a specific investment over a set period of time. Sometimes called the market capitalization rate.

9-4 Example: If Fledgling Electronics is selling for $100 per share today and is expected to sell for $110 one year from now, what is the expected return if the dividend one year from now is forecasted to be $5.00? Valuing Common Stocks

9-5 Total Return

9-6 Stock Prices and Returns

9-7 Stock Prices and Returns

9-8 Horizon longer than one year

9-9 Dividend-Discount Model

9-10 The price of a common stock today is equal to the present value of all future dividends! Note: Some firms, like Coca-Cola have paid dividends continuously for decades. Other firms, like Cisco Systems do not pay dividends. Are they worth nothing? No, we simply said the price of a stock is equal to all expected future dividends, which does not rule out the possibility that the company will some day start paying dividends. McDonald's, for instance, now pays dividends but did not pay a dividend for a many decades!

9-11 The Dividend-Discount Model Constant Dividend Constant Dividend Growth Changing Growth Rates

9-12 Constant Dividend If all expected future dividends are the same, (D 0 = D 1 = … D t =..), the present value of the dividend stream constitutes a perpetuity.. Assumes all earnings are paid to shareholders.

9-13 Example: Cooper, Inc.'s common stock currently pays a $1.86 dividend, which is expected to remain constant forever. If the required return on Cooper stock is 12%, what should the stock sell for today? Answer: P 0 = $1.86/.12 = $ Question: Given no change in the variables, what will the stock be worth in one year?

9-14 Answer: One year from now, the value of the stock, P 1, must be equal to the present value of all remaining future dividends. Since the dividend is constant, D 2 = D 1, and P 1 = D 2 /r = $1.86/.12 = $ In other words, in the absence of any changes in expected cash flows (and given a constant discount rate), the price of a no-growth stock will never change. Put another way, there is no reason to expect capital gains from this stock.

9-15 Constant Dividend Growth Model

9-16 Valuing a Firm with Constant Dividend Growth

9-17 Valuing a Firm with Constant Dividend Growth

9-18

9-19 Valuing a Firm with Two Different Growth Rates

9-20 Valuing a Firm with Two Different Growth Rates