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Lecture09_student - Valuingstocks...

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    Valuing stocks The complexities of valuing stocks When to take growth opportunities Price-earnings ratios
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How do we value stocks? Recall that there are three potential  ways that stocks have value Dividends Payments made directly to stockholders  Being bought out by another company Money given to stockholders after going  out of business
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Focusing on dividends We will pay most of our attention to  dividends This is how most of a stock’s value is  typically derived We will focus on some situations in  which all of a stock’s value is through  dividends Assume no uncertainty for now, except for  risk incorporated into the discount rate
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Thinking in terms of  perpetuities For many examples, we think of corporations  as being infinitely lived There is some risk the firm will go out of business We incorporate a higher discount rate in order to  accommodate the going-out-of-business risk For many firms, we do not necessarily expect  dividends to be the same each year Some examples will include zero growth in  expected dividends
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Growing perpetuities Many stocks are expected to pay higher  yearly dividends into the future Growth rate over time could be constant, or  could decrease once the corporation  reaches a certain size Example: 20% growth rate in dividends over  the next 10 years, followed by 8% growth  thereafter
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Time horizon issues Some people are concerned that  potential dividend payments made very  far into the future (>50 years) are not  valued in the market There are two ways to approach this Discounting far into the future Dividend vs. dividend/sales approaches to  stock valuation
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Discounting far into the future For even moderate discount rates,  payments made far into the future lead  to very little of a stock’s value Example: $5 dividend yearly forever
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$5 dividend yearly forever A stock only a has a small amount of its  value from dividends paid out more than  50 years in the future We are assuming a constant dividend each  year $5 dividend each year forever with  r  =  8% has a PV of $62.50 The same stock received 50 years from  now has PV of $1.33 Note: We assume that the first dividend payment is made one year from now
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Dividend vs. dividend/sales  approaches to stock valuation We can also compare a stock’s value  two ways to get PV Dividend stream approach Dividend/sales approach
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Dividend/sales approach We can value a stock into two components  using the dividend/sales approach The dividend paid one year from now The amount of money we can sell the stock for 
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This note was uploaded on 12/05/2011 for the course ECON 134a taught by Professor Lim during the Fall '08 term at UCSB.

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Lecture09_student - Valuingstocks...

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