Comm298-Week7-Stock_valuation_models-wit

Comm298-Week7-Stock_valuation_models-wit - Com298 Week 7...

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Com298: Week 7 Stock Valuation Models Learning Objectives: Focus on the following: Dividend discount model. DDM with growth assumptions. Earnings multiples valuation model. Price earnings ratio and NPV Growth Opportunities. Forward P/E and PEG Two Basic Approaches to Stock Valuation Discounted cash flow (DCF) models: 1
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Dividend discount model and its growth variation. Discounted free cash flow model. Relative valuation multiples: Price earnings ratio (P/E ratio). Price to book value (P/BV). Common Stock Valuation A simple Dividend Discount Model: PV(stock) = PV(expected future cashflows). P 0 = D 1 + P 1 2
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(1 + r) Let P 0 = the current price of a share P 1 = expected price at the end of a year D 1 = expected dividend per share (D 1 + P 1 ) = expected future cashflows Expected return (r ) = D 1 + ( P 1 P 0 ) P 0 Expected return (r ) = D 1 + ( P 1 P 0 ) P 0 P 0 Expected return is made up of the dividend yield plus the capital appreciation of the prices. Example Suppose the price of the stock for Moore Oil Inc. is expected to rise to $14 in one year and the company is expected to pay a dividend of $2 at that time. If investors expect a return of 20%, what is the current price of the stock ? Estimate the dividend yield and the capital gains yield. 3
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P 0 = D 1 + P 1 = 2 + 14 = 16 = 13.33 (1 + r) (1.20) 1.2 Expected return (r ) = D 1 + ( P 1 P 0 ) P 0 P 0 Expected return r = 2/13.33 + (14 – 13.3) / (13.33) Expected return r = 15% + 5% = 20% Dividend yield (D 1 / P 0 ) = 15% Price appreciation = (P 1 – P 0 ) = 5% P 0 Dividend Discount Model (DDM) The di vidend discount model estimates the current stock price P 0 as the present value of all expected future dividends. Some assumptions about dividend growth: Constant dividend 4
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The firm will pay a constant dividend forever. This is like a preferred stock. The price is computed using the perpetuity formula. Constant dividend growth The firm will increase the dividend by a constant percent every period. Non Constant Growth and Supernormal growth Dividend growth is not consistent initially, but settles down to constant growth eventually Dividend Discount Model: Assumption: Zero Growth DDM: with Zero Growth: If dividends are expected at regular intervals forever, then this is like a preferred stock and is valued as a perpetuity. P 0 = D / r Example: 5
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Suppose the stock is expected to pay a $0.50 dividend every quarter and the required return is 10% with quarterly compounding. What is the price? P
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This note was uploaded on 01/27/2011 for the course COMM 298 taught by Professor L during the Spring '10 term at Capilano.

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Comm298-Week7-Stock_valuation_models-wit - Com298 Week 7...

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