# Example 9 using the income statement and balance

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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