Investment in Long term Securities

Investment in Stocks

CHAPTER 8 – Risk, Return and Portfolio Theory8 - 4 Investment Common Stock The main features of the common stock: Typically each common stock owned entitles an investor to one vote in corporate shareholders’ meeting. Investor receives benefits in the form of dividends, capital gains or both. typically the firm does not pay all its earnings in cash dividends; special form of dividend is stock dividend, in which the corporation pays in stocks rather than cash. Common stock does not have a date on which the corporation must buy it back. But: some corporations pay cash to their shareholders by purchasing their own shares. These are known as share buybacks.

Main advantages of common stock : The investment income is usually higher; The investor can receive income in cash dividends; Common stock has a very high liquidity and can easily be moved from one investor to the other; Main disadvantages of common stock: Common stock is more risky in comparison with many other types of securities; The operating income is relatively low (the main income is received from the capital gain – change in stock price). Investment Common Stock

1. Fundamental analysis for investment decision making in stocks: 2. E-I-C analysis for investment decision making in stocks: 3. Categories of stocks: 4. Strategies for investing in stocks : Final Presentation and Assignment Topics Total marks = 15

Stock Valuation

What is valuation??? It is a process that links risk and return to determine the worth of an asset. Key inputs: There are three key inputs to valuation process. 1. Cash flows 2. Timing 3. (RRR)Required Rate of Return Investment in Common Stock

What is the value of an asset??

In financial markets, stock valuation is the method of calculating values of companies and their stocks. (means finding intrinsic value) The main use of these methods is to predict future market prices, and thus to profit from price movement of stocks that are judged Undervalued are bought, while stocks that are judged overvalued are sold, in the expectation that undervalued stocks will, on the whole, rise in value, while overvalued stocks will, on the whole, fall. What is stock valuation???

Stock valuation process: The process goes through the following steps 1. Forecasting of future cash flows for the stock. 2. Forecasting of the stock price. 3. Calculation of Present value of these cash flows. This result is intrinsic value of stock. 4. Comparison of intrinsic value of stock and current market price of the stock 5. Decision making whether to buy or to sell the stock.

What is the value of a stock???

Stock Valuation Methods

Stock valuation

1. Holding periods

Single holding period:

Multiple holding periods:

Solve these Questions 1. Suppose an investor expects to get $3.50 as dividend per share next year and hopes to sell the $ 45 at end of holding period. The required rate of return is 25%. Find the present value of this stock??? 2. Suppose an investor expects to receive $ 3.50, 4.50, 5.00, 5.50, and 6.00 at the end of 1st, 2nd, ……. Orderly, and hopes to sell this $ 65 at the end of holding period. If the investor’s RRR is 35% then Find present value of this stock. And decide if the investor would buy or hold the stock ???? Hint : Use single / multiple holding period Models

2. Growth rates What is growth Rate??? The rate at which the cash flow of a stock is expected to grow or increase is known as growth rate. The annualized percentage rate of growth that a particular stock's dividend undergoes over a period of time. A history of strong dividend growth could mean that future dividend growth is likely, which can signal long-term profitability for a given company.

How to calculate growth rate? The growth rate in dividends is calculated by using following formula: g = D0 – (Dt-1) ÷ Dt-1 Where g = growth rate Do = present dividend Dt = past dividend If the future dividend on a stock is $7.50 and past dividend is $4.00, then what is the growth rate??

Growth rate of dividend on a stock can be the followings; 1. Zero growth rate 2. Constant growth rate Based on each growth rate the dividend discount model result in different forms as shown in following slides. 2. Growth rates

Growth rates Models

Solve these questions Ex1: A company gives dividend of $ 7.50 per year with zero growth rate. The required rate of return is 20% find the present value. Ex2: A corporation pays $5 per share as dividend and has a policy to grow the dividend by 10% per year in future. If the required rate is 25% : 1. find the Po from given data 2. If the growth rate is constant for 5 year then what will be Po of this stock????