16 Security Analysis and 17 Fin Stat Analysis_Brief

16 Security Analysis and 17 Fin Stat Analysis_Brief -...

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Comm367 1 Dividend Discount Model (DDM) u Cash flows from holding a share: dividends + share price when the share is sold. If the share is held for 1 period, k P D P + + = 1 1 1 0 = + = + + + + + + = 1 3 3 2 2 1 0 ) 1 ( ) 1 ( ) 1 ( 1 t t t k D k D k D k D P According to the fundamental theory of valuation:
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Comm367 2 Discussions on the Growth Rate Earnings Addition to Retained Earnings Dividends b - = = 1 Earnings Dividends     ratio   payout Earnings RE   to   Add. ratio plowback  = b
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Comm367 3 Multistage Growth Model The assumption of constant growth rate is often too restrictive A popular extension of the constant growth model is the multistage growth model Two stage growth model
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Comm367 4 P/E Ratio Approach u Alternative approach often used by security analysts P0 = estimated earnings x P/E ratio = E1 x P0/E1
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Comm367 5 Understanding Price- Earnings Ratios u P/E ratios are a function of two factors Required return on the stock Firm’s growth prospects u Can firms increase payout ratio to increase market price? Will future growth prospects be affected? u Does rapid growth affect the riskiness of earnings? Will the required return be affected?
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Comm367 6 P/E Ratios and Interest Rates u A P/E ratio reflects investor optimism and pessimism Related to the required rate of return u As interest rates increase, required rates of return on all securities generally increase u P/E ratios and interest rates are inversely related
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Comm367 7 Earnings Estimates u Reported earnings per share u Security analysts’ forecasts of earnings Consensus forecast superior to individual Analysts are still frequently wrong u Earnings surprises The surprise element in earnings reports is what really matters
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16 Security Analysis and 17 Fin Stat Analysis_Brief -...

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