Example 9:
Using the income statement and balance sheet
for HWP, estimate a price for the company’s stock (year end
1999) using the constant growth dividend discount model.
You will need estimates for D1, g and r
s
. (Note you will need
to look at chapter 6 page 226-228 – the CAPM model to
calculate r
s.
)
Required Return (r
s
) Data
Market Premium
9.0%
Risk Free Rate
5.0%
Beta
1.05
11

Dividend Growth Models: Advantages and
Disadvantages
•
Advantages
•easy to compute
•2 stage allows for two different growth rates
•
Disadvantages
•not usable for firms paying no dividends
•sensitive to choice of g and r
•r and g may be very difficult to estimate
•constant perpetual growth is often unrealistic
12

2. Market Multiple Analysis
The idea here is to use historical averages of ratios or most
recent ratio to estimate the expected price of a stock (EP).
There are 3 ratios which are widely used:
•
P/E ratio - Price to earnings ratio
•
current stock price divided by annual EPS
Formula: EP = P/E ratio x EPS x (1 + Earnings growth
rate)
•
Price/Cash flow ratio
•
cash flow = net income + depreciation = cash flow
from operations
Formula: EP = P/CF ratio x CFPS x (1 + CF growth rate)
Price/Sales
•
current stock price divided by annual sales per
share
Formula: EP = P/S ratio x SPS x (1 + Sales growth rate)
13

Price-Ratio Analysis for HWP
Example 10:
Compute the expected price of HWP using the
ratio information given:
14
1995
1996
1997
1998
1999
Average
EPS
$1.16
$1.27
$1.48
$1.44
$1.50
P/E
19.52
16.98
20.36
20.46
24.18
20.30
CFPS
$1.75
$1.96
$2.25
$2.43
$2.21
P/CFPS
12.94
11.01
13.39
12.12
16.41
13.17
SPS
$15.45
$18.94
$20.60
$23.17
$21.09
P/SPS
1.47
1.14
1.46
1.27
1.72
1.41

Secondary Markets
•
3
Ways to transact
•
Directly with other investors
•
Indirectly through a broker (most done here)
•
Directly with a dealer
•
Dealers vs Brokers
•
Dealers hold inventory, brokers do not
•
Dealer buys at the bid, sells at the ask = profit (think of
the USF book store)
•
Trading from inventory is the dealers bread and butter
•
Commissions are the brokers’ bread and butter
•
Broker is a matchmaker of sorts (why?)
•
Where? Exchanges
•
NYSE, AMEX, the “regionals”
•
Nasdaq
15

NYSE (founded 1792) “The Big Board”
•
Membership
•
1,366 members -- “own seats”
member firm
•
1 firm can own numerous seats
•
Buying/leasing(1/2) a seat
•
$50,000 - $2,000,000
•
Member Types (in order by size)
•
Commission brokers (~500)
•
Specialists (~400)
•
Specialist firms (~35 of them)
•
Floor / $2 brokers from history – becoming obsolete
due to SuperDot system
•