stockval - Stock Valuation Economics 71a: Spring 2007 Mayo...

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Stock Valuation Economics 71a: Spring 2007 Mayo 11 Malkiel, 5, 6 (136-144), 8 Lecture notes 4.2
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Goals Dividend valuation model “dividend discount model” Forecasting earnings, dividends, and prices Ratio valuations Malkiel’s “Firm foundations”
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Dividend Discount Model Constant Dividends Evaluate stream of dividends Stock pays the same constant dividend forever Assume some “required return” = k k = RF + RP k = RF + beta(E(Rm)-RF) Same as perpetuity formula
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Dividend Discount Model Constant Dividends P = PV = d (1+ k ) t t =1 ¥ å = d k
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Dividend Discount Model Growing Dividends Evaluate stream of growing dividends g = growth rate d t = (1+ g ) t d 0
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More Growing Dividends PV = (1+ g ) t d 0 (1+ k ) t t =1 ¥ å = d 0 a t t =1 ¥ å a = 1+ g 1+ k PV = a (1- a ) d 0 = (1+ g ) (1+ k ) 1- (1+ g ) (1+ k ) d 0 = (1+ g ) (1+ k ) ( k - g ) (1+ k ) d 0 PV = (1+ g ) ( k - g ) d 0 = 1 ( k - g ) d 1
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Dividend Discount Must have k>g for this to make sense Otherwise, dividends growing too fast Basic feature: Very sensitive to g
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Examples Let initial d = 1, k=0.05, g=0.02 PV = 1.02/(0.05-0.02) = 34 k = 0.05, g = 0.03 PV = 1.03/(0.05-0.03) = 51.5 Why is this important? Stock prices Small changes in beliefs lead to big changes in prices
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What if dividends not growing forever? Solve this by calculator or computer for d(t) P = d t (1+ k ) t t =1 ¥ å
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Goals Dividend valuation model “dividend discount model” Forecasting earnings, dividends, and prices Ratio valuations Malkiel’s “Firm foundations”
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Future Price Estimates Variable Growth Model Forecast dividends in early years In last year Estimate dividend growth Use this to estimate future price
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Present Value Calculation (End of year dividends.) P 2007 = d 2007 (1 + k ) + d 2008 (1 + k ) 2 + d 2009 (1 + k ) 3 + P 2009 (1 + k ) 3 P 2009 = (1 + g ) ( k - g ) d 2009
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Forecasting Dividends Forecast sales revenue Guess revenue growth rates Sales tomorrow = (1+g) (Sales today)
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stockval - Stock Valuation Economics 71a: Spring 2007 Mayo...

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