1. Fin 307-Stocks Valuation | Dr. Menahem Rosenberg
Valuation of Stocks
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

2. Fin 307-Stocks Valuation | Dr. Menahem Rosenberg
Asset Valuation
Asset Value as Present Value of the Cash Flows it will produce:
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

3. Fin 307-Stocks Valuation | Dr. Menahem Rosenberg
Stocks Features
Represents (residual) ownership.
Ownership implies control.
Stockholders elect directors.
Directors elect management.
Management’s goal: Maximize stock price.
Stocks certificate represent proportional ownership.
Stocks certificate entitle its holders to proportional distributions (mainly dividend), if there are any.
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

4. The Discounted Dividend Model
A discounted dividend model is any model that computes the value of a share of a stock as the present value of the expected future cash dividends
Using (1) above: Let: P0 be the present stock price, Dt - Cash dividend per share at time t r – discount rate
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

5. The Discounted Dividend Model
Alternative view of the Model.
Assume a risk less environment
Every investor takes a position in a stock for one period only.
P1 -the price the next investor will pay for the stock in period 1, after dividend in that period is paid
Repeated substitution will result in (2)
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

6. Fin 307-Stocks Valuation | Dr. Menahem Rosenberg
The Dividend Model
Case 1: Constant Dividend When all dividends are the same D0 = D1 = D2 = ….
The dividend stream is treated as a perpetuity
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

7. Fin 307-Stocks Valuation | Dr. Menahem Rosenberg
Dividend Growth Model
Case 2: Constant Growth Dividend
When dividend grow at constant growth rate g from D1 and on and g<r (normal growth)
D2 = D1(1+g) D3 = D2(1+g) = D1(1+g)2
The dividend stream is treated as a constant growth perpetuity
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

8. Fin 307-Stocks Valuation | Dr. Menahem Rosenberg
Dividend Growth Model
Case 3: Limited abnormal growth continued by Constant Growth Dividend
Let dividend grow at g1> r rate for t periods, and from t+1 grow forever at a constant growth rate g2< r .
Compute (6.1) Dt+1= Dt (1+ g2) = D0(1+ g1)t (1+ g2)
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

9. Fin 307-Stocks Valuation | Dr. Menahem Rosenberg
Dividend Growth Model
Which can be substituted with a growing annuity
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

10. Where is Growth Coming from ?
Review: Net Income = Retained earning + Dividend
Retained earning are additions to equity, therefore, next period the increase in NI = ROE * Retained earning
Therefore, growth (7) g= ROE*(Retention Ratio)
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg

11. Price and Investment Opportunities
The price of a stock that pays out 100% of its earning :
If the firm decides to retain earning and invest in new project, its value will increase by exactly the projects’ NPV.
7/23/2019
Fin 307-Stocks Valuation | Dr. Menahem Rosenberg