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Equity+Valuation - Equity Valuation Reading Chapter 18 1...

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1 Equity Valuation Reading: Chapter 18
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2 Keys to Fundamental Valuation of Common Stocks Cash flows to shareholders (dividends) Required rate of return Determined by Economy’s risk-free rate of return (including expected rate of inflation during the holding period) + Risk premium determined by the uncertainty of returns (risk) Asset pricing models: CAPM, APT, etc.
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3 Intrinsic Value vs. Market Price Fundamental analysis of equity valuation attempts to establish an intrinsic value and identify good investment opportunities Caveat : intrinsic value is subjective and not directly observable An example: Carolina Ventures Inc. is currently selling at $38/share. It is expected to pay $2/share dividends next year and to sell at $44 a year later. The stock risk has been evaluated to have b = 1.2. Is this stock a good buy? The expected return on S&P is 12% and the risk-free rate is 5%.
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4 Intrinsic Value vs Market Price Required return by CAPM: Another way to look at it
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5 Dividend Discount Model (DDM) In general, if you hold the security for one year, its intrinsic value (or fair value) should be This is the dividend discount model (DDM). ( ) ( ) ( ) ( ) ... 1 ... 1 1 1 1 1 , 1 , 1 2 2 1 0 2 2 2 2 1 0 2 2 1 1 1 0 + + + + + + + = + + + + + = + + = + + = τ τ k D k D k D V k P k D k D V k P D P k P D V at arrive will you continue, you As so But rate.) tion capitaliza market called is it (Sometimes stock. the on return of rate required the is k where
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