Stocks and Their Valuation

Stocks and Their Valuation - Stocks and Their Valuation...

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Stocks and Their Valuation Chapter 9 9-1
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Learning Objectives Features of Common Stock Determining Common Stock Values Preferred Stock
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Facts about Common Stock Represents ownership Ownership implies control Stockholders elect directors Directors elect management Management’s goal: Maximize the stock price 9-3
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Intrinsic Value and Stock Price Outside investors, corporate insiders, and analysts use a variety of approaches to estimate a stock’s intrinsic value (P 0 ). In equilibrium we assume that a stock’s price equals its intrinsic value. Outsiders estimate intrinsic value to help determine which stocks are attractive to buy and/or sell. Stocks with a price below (above) its intrinsic value are undervalued (overvalued ). 9-4
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Determinants of Intrinsic Value and Stock Prices 9-5 “True” Investor Cash Flows “True” Risk “Perceived” Investor Cash Flows “Perceived” Risk Managerial Actions, the Economic Environment, Taxes, and the Political Climate Stock’s Intrinsic Value Stock’s Market Price Market Equilibrium: Intrinsic Value = Stock Price
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Different Approaches for Estimating the Intrinsic Value of a Common Stock Discounted dividend model Corporate valuation model P/E multiple approach EVA approach 9-6
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Discounted Dividend Model Value of a stock is the present value of the future dividends expected to be generated by the stock. 9-7 ) r (1 D ... ) r (1 D ) r (1 D ) r (1 D P ˆ s 3 s 3 2 s 2 1 s 1 0
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Constant Growth Stock 9-8 A stock whose dividends are expected to grow forever at a constant rate, g. D 1 = D 0 (1 + g) 1 D 2 = D 0 (1 + g) 2 D t = D 0 (1 + g) t If g is constant, the discounted dividend formula converges to: g r D g r g) (1 D P ˆ s 1 s 0 0
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Future Dividends and Their Present Values 9-9 $ 0.25 Years (t) 0 t t t ) r 1 ( D PVD t 0 PVD P t 0 t ) g 1 ( D D
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