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MGT+3062+Valuing+Stock+student+version

# MGT+3062+Valuing+Stock+student+version - ValuingStocks:...

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1 Valuing Stocks: The dividend discount model Financial Management - MGT 3062 Barry Marchman, PhD.

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2 Objectives Describe the relation between dividends, discount rates,  growth, and stock prices Solve three types of dividend discount model problems Zero growth Constant Growth Differential Growth Value stocks using comparable firms
3 What is a stock? It’s an ____________ stake in the company __________ claimholder Have _________ rights You get ____________ in two ways from buying stock: The company _________________________ You _________ your shares,  Either to another investor in the market  Or back to the company

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4 Some definitions Dividends Distributions from a company to _______________.  Dividends are usually received in _______________ Where do they come from: Firm decides to pay out a portion of ______________ to stockholders _____________  ratio   Keeps the rest for other investments ________________ Ratio What do you get when you own a stock? Future ______________ D i  ; i=1,2,3,… Future ______________ P t   (Capital Gain)
5 Graphical Illustration of the Firm Financial manager (1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors (1) (2) (3) (4a) (4b) Firm‘s operations: e.g. projects Financial markets: e.g. investors

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6 Price of a stock The stock’s price is equal to: __________________ of the dividends plus the  __________________ value of the sales price Suppose we have a single holding period: We buy a stock today at t=0 and sell the stock one year later at t=1 Then the price of the stock today should be: ) 1 ( 1 1 0 0 r D P PV P + + = =
7 What determines P 1 ? Apply the PV formula again: Substituting this into the previous formula: ) 1 ( 2 2 1 1 r D P PV P + + = = 2 2 2 1 0 0 ) 1 ( ) 1 ( r D P r D PV P + + + + = =

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8 General Formula for Stock Price We can keep repeating the process: Or equivalently, In other words, the price of a stock today equals the present value of the  entire dividend stream that the stock will pay in the future   ... ) 1 ( ) 1 ( ) 1 ( 3 3 2 2 1 0 + + + + + + = r D r D r D P t t t r P D r D r D r D P ) 1 ( ... ) 1 ( ) 1 ( ) 1 ( 3 3 2 2 1 0 + + + + + + + + + =
9 Why are we discounting dividends? Why not earnings? We discount dividends because: We buy a stock for what we can get out of it 1. 2. Only a portion of earnings is paid to stockholders

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10 Estimating the Stock Price An analyst must have two inputs to estimate a stock price: 1. 2. We will focus on the problem of estimating __________ We will consider three basic scenarios: __________________________ in dividends __________________________ in dividends __________________________ in dividends
11 A caveat In practice, the valuation of stocks is difficult Future cash flows are _______________ Firms live __________ in some cases The __________________ is not easily observed It’s much more challenging than bonds We know the ________________ for bonds Bonds have an ______________________

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MGT+3062+Valuing+Stock+student+version - ValuingStocks:...

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