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# stockval - 1 Stock Valuation Economics 71a Spring 2007 Mayo...

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Unformatted text preview: 1 Stock Valuation Economics 71a: Spring 2007 Mayo 11 Malkiel, 5, 6 (136-144), 8 Lecture notes 4.2 Goals Dividend valuation model “dividend discount model” Forecasting earnings, dividends, and prices Ratio valuations Malkiel ’ s “Firm foundations” 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 Dividend Discount Model Constant Dividends P = PV = d (1 + k ) t t = 1 ! " = d k 2 Dividend Discount Model Growing Dividends Evaluate stream of growing dividends g = growth rate d t = (1 + g ) t d More Growing Dividends PV = (1 + g ) t d (1 + k ) t t = 1 ! " = d a t t = 1 ! " a = 1 + g 1 + k PV = a (1 # a ) d = (1 + g ) (1 + k ) 1 # (1 + g ) (1 + k ) d = (1 + g ) (1 + k ) ( k # g ) (1 + k ) d PV = (1 + g ) ( k # g ) d = 1 ( k # g ) d 1 Dividend Discount Must have k>g for this to make sense Otherwise, dividends growing too fast Basic feature: Very sensitive to g 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 2 Dividend Discount Model Growing Dividends Evaluate stream of growing dividends g = growth rate d t = (1 + g ) t d More Growing Dividends PV = (1 + g ) t d (1 + k ) t t = 1 ! " = d a t t = 1 ! " a = 1 + g 1 + k PV = a (1 # a ) d = (1 + g ) (1 + k ) 1 # (1 + g ) (1 + k ) d = (1 + g ) (1 + k ) ( k # g ) (1 + k ) d PV = (1 + g ) ( k # g ) d = 1 ( k # g ) d 1 Dividend Discount Must have k>g for this to make sense Otherwise, dividends growing too fast Basic feature: Very sensitive to g 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?...
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stockval - 1 Stock Valuation Economics 71a Spring 2007 Mayo...

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