Lecture 5-3.ppt - Lecture 5 Equity valuation Dividend...

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Lecture 5 - Lecture 5 - Equity valuation Equity valuation
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Dividend Discount Model (DDM) Dividend Discount Model (DDM) Dividend Discount Model (DDM) P t t t+1 D t+1 P t+1 2
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Stock returns Stock returns Gross return from time t to time t+1: For example, we bought a stock for 50, at the end of the period its price was 55. Also, during the period we received $2 as dividends. The gross return is: t t t t P D P R 1 1 1 14 . 1 50 2 55 1 t R 3
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Stock returns Stock returns It is common to talk about net returns: In the example: Many times we divide the return into two components: 1 1 1 1 t t t t P D P r % 14 14 . 0 1 50 2 55 1 t r t t t t t t t t t P D P P P P D P r 1 1 1 1 1 1 Capital gain/loss yield Dividend yield 4
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Stock returns Stock returns We need to distinguish between actual returns and expected returns: at time t we know P t but we do not know P t+1 and D t+1. It follows that: According to the CAPM: 1 1 1 1 t t t t P D P E r E 1 1 1 1 t t t t r E D P E P 1 1 , 1 1 ft t m ft t r r E r r E 5
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Dividend Discount Model Dividend Discount Model 1 1 1 0 1 r E D P E P 1 2 2 2 1 r E D P E P 1 1 1 1 1 2 2 2 2 1 2 2 1 0 k P E k D E k D E k k D P E D E P 6
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DDM DDM Also so By repeated substitutions we have 1 3 3 2 k D P E P 3 3 3 3 2 2 1 0 2 3 3 2 2 1 2 2 1 0 1 1 1 1 1 1 1 1 1 1 k P E k D E k D E k D E P k k D P E k D E k D E k k D P E D E P 7
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DDM DDM This is called the Dividend Discount Model. We need to form expectations for the future dividends. 1 0 1 t t t k D E P 8
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The Gordon model The Gordon model Assuming dividends will grow indefinitely at a constant rate g it follows that If g<k then 1 0 0 1 1 t t t k g D P g k D E g k g D P 1 0 0 1 9
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The Gordon model The Gordon model Example: a company just distributed $3 to each share as dividends. The dividend is expected to grow at a rate of 8% forever. The beta of the stock is 1, the risk free rate is 6% and the market risk premium is 8%. What is the value of the stock?
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  • Fall '17
  • Valuation, Dividend yield, P/E ratio, PE ratio

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