Download presentation

Presentation is loading. Please wait.

Published byBlake Hill Modified over 7 years ago

1
1 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Fin2808: Investments Spring, 2010 Dragon Tang Lectures 13 & 14 Equity Valuation Models March 9&11 ， 2010 Readings: Chapter 18 Practice Problem Sets: 1,5,7,14, 16,17

2
2 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation How to make money in stocks?

3
3 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation How to make money in stocks? Capital gains: buy low/sell high –Growth companies Dividend yields: income stream –Matured (value) companies

4
4 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Equity Valuation Objectives: Calculate the intrinsic value of a firm using either a constant growth or multistage dividend discount model. Calculate the intrinsic value of a stock using a dividend discount model in conjunction with a price/earnings ratio. Assess the growth prospects of a firm from it P/E ratio.

5
5 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Balance Sheet Valuation Methods Book Value Liquidation Value Replacement Cost

6
6 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Expected Holding Period Return If E(HPR) > Required Rate of Return(RRR), the stock is a good deal. RRR is from a pricing model, e.g. CAPM: In market equilibrium, E(HPR) = RRR.

7
7 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Intrinsic Value versus Market Price V 0 (intrinsic value) > P 0 (market price) buy V 0 (intrinsic value) < P 0 (market price) sell or sell short In market equilibrium, V 0 = P 0 k is the market capitalization rate which equates V 0 and P 0 If V 0 P 0, then EMH implies the estimate of k is wrong Intrinsic value --The present value of a firm’s expected future net cash flows discounted by the required rate of return.

8
8 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Dividend Discount Models One Period Case: Multi-period Case: Where D 1,…, D H and P H are expected values

9
9 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Dividend Discount Models Example: Whitewater Rapids Company is expected to have dividends grow at a rate of 12% for the next three years. In three years, the price of the stock is expected to be $ 74.46. If Whitewater just paid a dividend of $2.00 and its level of risk requires a discount rate of 10%, what is the intrinsic value of Whitewater stock?

10
10 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Dividend Discount Models Dividend discount model (infinite horizon):

11
11 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Constant Growth DDM (Gordon’s Model)

12
12 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Constant Growth DDM Example: Whitewater Rapids Company is expected to have dividends grow at a constant rate of 6% for the foreseeable future. If Whitewater just paid a dividend of $2.81 and its level of risk requires a discount rate of 10%, what is the intrinsic value of Whitewater stock?

13
13 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Market Capitalization Rate If V 0 = P 0 : Dividend Yield Capital Gains Yield Gordon’s Model: If g = 0: Perpetuity

14
14 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Implications of this Model If D 1 increases, then V 0 increases. If k decreases, then V 0 increases. If g increases, then V 0 increases. If D 1 increases X%, then V 0 will increase X%. g = the capital gains yield

15
15 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Dividend Payout Ratio and Plowback Ratio Dividend Payout Ratio: Percentage of earnings paid out as dividends Plowback (or Earning Retention) Ratio: Fraction of earnings retained and reinvested in the firm

16
16 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Stock Prices and Investment Opportunities If a firm retains earnings and reinvest them in a profitable investment opportunity, dividend may grow “faster”. If a firm pays out all dividends nothing gets re-invested, nothing growths.

17
17 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Figure 12.1 Dividend Growth for Two Earnings Reinvestment Policies

18
18 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Plowback Ratio and Growth Where: ROE = Return on Equity b = Plowback Ratio (or Earning Retention Ratio)

19
19 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Stock Prices and Investment Opportunities Present value no-growth (b=0 or ROE=k) Present value of growth Opportunities PVGO > 0 if ROE>k PVGO <0 if ROE<k

20
20 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Estimating Growth Example: Takeover Target has a plowback ratio of 60% and an ROE of 10%. If it expects earnings to be $ 5 per share, what is the present value of Takeover’s growth opportunities if the appropriate capitalization rate is 15%? What is the PVGO?

21
21 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Life Cycles and the Constant Growth Model Changing growth rates: temporary high (or low) growth permanent constant growth

22
22 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Changing Growth Rate Example: Whitewater Rapids Company is expected to have dividends grow at a rate of 12% for the next three years. In three years, the dividends will settle down to a more sustainable growth rate of 6% which is expected to last “forever.” If Whitewater just paid a dividend of $2.00 and its level of risk requires a discount rate of 10%, what is the intrinsic value of Whitewater stock?

23
23 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Price-Earning (P/E) Ratios Ratio of Stock price to its earnings per share Useful for firm valuation: Problems: –Forecasts of E –Forecasts of P/E

24
24 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation P/E Ratios and Growth If PVGO = 0:

25
25 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Numerical Example: No Growth E 0 = $2.50 g = 0 k = 12.5% P 0 = D/k = $2.50/.125 = $20.00 P/E = 1/k = 1/.125 = 8

26
26 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation P/E Ratios and ROE P/E ratio rises with ROE but not necessarily with b 1/k ROE<k ROE>k b P/E

27
27 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Numerical Example with Growth b = 60% ROE = 15% (1-b) = 40% E 1 = $2.50 (1 + (.6)(.15)) = $2.73 D 1 = $2.73 (1-.6) = $1.09 k = 12.5% g = 9% P 0 = 1.09/(.125-.09) = $31.14 P/E = 31.14/2.73 = 11.4 P/E = (1 -.60) / (.125 -.09) = 11.4

28
28 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Figure 12-3 P/E Ratio of the S&P 500 Index and Inflation

29
29 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Caveat with P/E Ratios High plowback ratio (b) High Growth Rate (g) (g = ROE*b) BUT High g (if due to high b) High P/E ratio Practitioners: high P/E as proxy of high dividend growth (g)

30
30 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation P/E ratio and Risk Holding everything equal: High risk (k), Low P/E. Why do small-risky firm have high P/E?

31
31 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Pitfalls in P/E Analysis Earnings are based on accounting data Current price and current earnings Future expected earnings is more appropriate In P/E formula, E is an expected trend In financial pages, E is the actual past period's earnings

32
32 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Figure 12-6 P/E Ratios

33
33 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Combining P/E and DDM

34
34 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation The Aggregate Stock Market: Earning Multiplier Approach

35
35 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Other Valuation Ratios & Approaches Price-to-book Price-to-cash flow Price-to-sales Present Value of Free Cash Flow

36
36 FIN 2808, Spring 10 - Tang Chapter 18: Equity Valuation Summary Valuation approaches: -Balance sheet values -Present value of expected future dividends DDM states that the price of a share of stock is equal to the present value of all future dividends discounted at the appropriate required rate of return Constant growth model DDM: P/E ratio is an indication of the firm's future growth opportunities Models used for the firm can be used to forecast the behavior of the aggregate stock market

Similar presentations

© 2023 SlidePlayer.com Inc.

All rights reserved.

To make this website work, we log user data and share it with processors. To use this website, you must agree to our Privacy Policy, including cookie policy.

Ads by Google