Valuation of Stock

# Valuation of Stock - VALUATION VALUATION CHARACTERISTICS OF...

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1 VALUATION & VALUATION & CHARACTERISTICS OF CHARACTERISTICS OF STOCK STOCK Stony Brook College of Business BUS 330 V. Giardini

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2 RETURN ON INVESTMENT RETURN ON INVESTMENT Future cash flow associated with stock ownership consists of dividends and the eventual selling price of the shares Return (k) = [D 1 + (P 1 - P 0 )] / P 0 or Return (k) = D 1 / P 0 + (P 1 - P 0 ) / P 0
3 DIVIDEND AND CAPITAL DIVIDEND AND CAPITAL GAIN YIELDS GAIN YIELDS Dividend Capital Gain Yield Yield k = D P + (P - P P 1 0 1 0 0 )

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4 THE NATURE OF THE CASH FLOWS FROM THE NATURE OF THE CASH FLOWS FROM COMMON STOCK OWNERSHIP COMMON STOCK OWNERSHIP Analogous to bonds A regular series followed by a return of invested funds however Far less precise and regular Not contractually guaranteed Years 0 1 2 3 n-1 n D 1 D 2 D 3 D n-1 D n P n Figure 7-1 Cash Flow Time Line for Stock Valuation
5 THE BASIS OF VALUE THE BASIS OF VALUE Make an assumption about the behavior of future dividends and the eventual selling price Then take the present value of future cash flows P 0 = D 1 [PVF k,1 ] + D 2 [PVF k,2 ] + . . . . . . + D n [PVF k,n ] + P n [PVF k,n ]

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6 Example: Joe Simmons is interested in the stock of Teltex Corp. He feels it will pay dividends of \$2 and \$3.50 in the next two years, after which its price will be \$75. Similar stocks return 12%. What should Joe be willing to pay for Teltex? Solution: P 0 = D 1 [PVF k,1 ] + D 2 [PVF k,2 ] + P 2 [PVF k,2 ] = \$2.00[PVF 12,1 ] + \$3.50[PVF 12,2 ] + \$75.00[PVF 12,2 ] = \$2.00[.8929] + \$3.50[.7972] + \$75.00[.7972] = \$64.37 Buy if the price is below about \$64
Fundamental Analysis Fundamental Analysis The Intrinsic (Calculated) Value and Market Price Joe's research led to a forecast of future dividends and prices which led to a value of about \$64. If other investors don't agree their intrinsic values will be different. Market price is a consensus of everyone's

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## This note was uploaded on 02/15/2012 for the course GERM 200 taught by Professor Kuhmar during the Spring '10 term at SUNY Albany.

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Valuation of Stock - VALUATION VALUATION CHARACTERISTICS OF...

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