Scribd Logo
Upload

Welcome to Scribd!

  • 72 views

    Stocks and Stocks Valuation

    Uploaded by

    ERICKA MAE BALDEMOR
    The document discusses various aspects of stock valuation, including: - Stocks represent ownership interests in companies and have characteristics like common stock and preferred stock. - Valuing stocks is more difficult than valuing bonds because future dividends are uncertain, stocks have no maturity date, and required rates of return are not directly observable. - Valuation models include absolute models like the dividend discount model that value stocks based on fundamentals, and relative models that compare ratios and multiples to similar companies. - The dividend discount model values stocks based on the present value of expected future dividends, using assumptions about dividend growth rates, required rates of return, and time horizons.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd

    Stocks and Stocks Valuation

    Uploaded by

    ERICKA MAE BALDEMOR
    72 views57 pages
    The document discusses various aspects of stock valuation, including: - Stocks represent ownership interests in companies and have characteristics like common stock and preferred stock. - Valuing stocks is more difficult than valuing bonds because future dividends are uncertain, stocks have no maturity date, and required rates of return are not directly observable. - Valuation models include absolute models like the dividend discount model that value stocks based on fundamentals, and relative models that compare ratios and multiples to similar companies. - The dividend discount model values stocks based on the present value of expected future dividends, using assumptions about dividend growth rates, required rates of return, and time horizons.

    Original Title

    STOCKS-AND-STOCKS-VALUATION (1)

    Copyright

    © © All Rights Reserved

    Available Formats

    PPTX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    The document discusses various aspects of stock valuation, including: - Stocks represent ownership interests in companies and have characteristics like common stock and preferred stock. - Valuing stocks is more difficult than valuing bonds because future dividends are uncertain, stocks have no maturity date, and required rates of return are not directly observable. - Valuation models include absolute models like the dividend discount model that value stocks based on fundamentals, and relative models that compare ratios and multiples to similar companies. - The dividend discount model values stocks based on the present value of expected future dividends, using assumptions about dividend growth rates, required rates of return, and time horizons.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    72 views57 pages

    Stocks and Stocks Valuation

    Uploaded by

    ERICKA MAE BALDEMOR
    The document discusses various aspects of stock valuation, including: - Stocks represent ownership interests in companies and have characteristics like common stock and preferred stock. - Valuing stocks is more difficult than valuing bonds because future dividends are uncertain, stocks have no maturity date, and required rates of return are not directly observable. - Valuation models include absolute models like the dividend discount model that value stocks based on fundamentals, and relative models that compare ratios and multiples to similar companies. - The dividend discount model values stocks based on the present value of expected future dividends, using assumptions about dividend growth rates, required rates of return, and time horizons.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 57

    STOCKS AND STOCKS

    VALUATION
    FINANCIAL MARKETS
    STOCKS

     MEDIUM TO HIGH-RISK SECURITIES


     STOCK MARKET (SECONDARY) ARE WAY MORE EFFICIENT THAN BONDS MARKET
    (INDEXES AND CENTRALIZED TRADING PLATFORM – NYSE, NASDAQ)
     UNLIKE BONDS – THE CASH FLOWS FOR THESE ARE USUALLY MUCH DIVERSE
    AND “UNGUARANTEED”
     HAS A LOT OF PRICING / VALUATION MODELS
    TYPES OF STOCKS

     COMMON STOCKS
     PREFERRED STOCKS
    COMMON STOCKS
     REPRESENTS AN OWNERSHIP INTEREST
     RESIDUAL CLAIMANTS – LOWEST PRIORITY CLAIM OF FIRM’S
    ASSETS
     NO FIXED DIVIDENDS
     HAS VOTING RIGHTS
     TRUE PERPETUITIES – HAVE NO MATURITY VALUE
    PREFERRED STOCKS
     ALSO REPRESENTS AN OWNERSHIP INTEREST
     TAKE PRECEDENCE OVER COMMON STOCKHOLDERS IN THE
    PAYMENT OF DIVIDENDS AND IN THE DISTRIBUTION OF
    CORPORATE ASSETS IN THE EVENT OF LIQUIDATION
     HAS FIXED DIVIDENDS (BUT STILL UNGUARANTEED – STILL NOT
    A CONTRACTUAL OBLIGATION UNLIKE INTEREST PAYMENTS ON
    BONDS)
     HAS NO VOTING RIGHTS
     USUALLY NOT TRUE PERPETUITIES – HAVE NO MATURITY VALUE
     ALSO KNOWN AS A “HYBRID SECURITY”
    STOCK VALUATION
    STOCK VALUATION
     When stock prices rise or fall, how do investors or financial
    managers know when it is time to buy or sell?

     How can they tell if the market price of stock reflects its value?

     You can’t just rely on your feeling or emotions, you need to have a
    reasonable expectations regarding the value of the future cash
    flows that ownership of stocks would entitle them to receive.
    STOCK VALUATION

     One of the approach is to develop a stock-valuation model and


    COMPARE the value of the estimated from the model with the
    market price.

     From there, you can have better investment decisions because,


    you have a reasonable basis to determine of the stock is
    OVERVALUED or UNDERVALUED.
     In valuing bonds we emphasized that the value of any asset is the
    present value of its future cash flows. The steps in valuing an asset
    are as follows:

    1. Estimate the future cash flows.


    2. Determine the required rate of return, or discount rate, which
    reflects the riskiness of the future cash flows.
    THE CHALLENGE:

    It is relatively straightforward to apply these steps in


    valuing a bond because the cashflows are stated as part of
    the bond contract and the required rate of return or
    discount rate is just the yield to maturity on bonds with
    comparable risk. However, common stock valuation is
    MORE DIFFICULT for several reasons
    BRAIN EXERCISE

    Given the characteristics of a stock, what


    could be the possible challenges in valuing a
    stock?
    REASON #1
    While the expected cash flows for bonds are well documented and easy
    to determine, common stock dividends are much less certain.

    Dividends are declared by the board of directors, and a board may or


    may not decide to pay a cash dividend at a particular time. Thus, the
    size and the timing of dividend cash flows are less certain
    REASON #2

    Common stocks are true perpetuities in that they have no


    final maturity date. Thus, firms never have to redeem
    them. In contrast, bonds have a finite maturity
    REASON #3

    Finally, unlike the rate of return, or yield, on


    bonds, the rate of return on common stock is not
    directly observable. Thus, grouping common stocks
    into risk classes is more difficult than grouping
    bonds
    TYPES OF STOCK VALUATION

    1. ABSOLUTE
    2. RELATIVE
    WATCH THIS VIDEO

    https://
    www.investopedia.com/articles/fundamental-analysis/11/choosing-valuation-me
    thods.asp
    ABSOLUTE VALUATION
    Absolute valuation models attempt to find the intrinsic or "true" value of an
    investment based only on fundamentals.

    Looking at fundamentals simply means you would only focus on such things as
    dividends, cash flow, and the growth rate for a single company—and not worry
    about any other companies.

    Valuation models that fall into this category include the dividend discount
    model, discounted cash flow model, residual income model, and asset-based
    model.
    RELATIVE VALUATION
    Relative valuation models, in contrast, operate by comparing the company in
    question to other similar companies. These methods involve calculating 
    multiples and ratios, such as the price-to-earnings (P/E) ratio, and comparing
    them to the multiples of similar companies.

    For example, if the P/E of a company is lower than the P/E of a comparable
    company, the original company might be considered undervalued.

    Typically, the relative valuation model is a lot easier and quicker to


    calculate than the absolute valuation model, which is why many investors and
    analysts begin their analysis with this model.
    HEADS UP…
    In all models below, we assume that:
    1. The current dividend has just been paid (immediately before we buy the
    stock) and our first dividend received will be one year from today.
    2. We also assume that dividends are paid annually instead of quarterly or
    semi-annually. These assumptions make the application of time value of
    money simpler.

    While they may not be realistic, they do not greatly alter the results and
    therefore are worthwhile simplifications.
    NO GROWTH

    If we have a stock with no growth in its dividends over time, the


    infinity issue is solved with a perpetuity. The stockholder will
    receive the same dividend every year (an annuity) that lasts
    forever.

    This is the perpetuity concept that was introduced in the Time


    Value of Money chapter. The most common example of a no
    growth stock is a PREFERRED STOCK.
    According to the no-growth model, to find the value of the stock, we just take
    the current dividend and divide by the required return (remember, it’s just a
    perpetuity — an infinite annuity — since the stock has no maturity date and the
    dividend is not expected to increase or decrease in value).
    You may have concerns about the assumption
    of an infinite time horizon. In practice,
    though, it does not present a problem. It is
    true that most companies do not live on
    forever.

    We know, however, that the further in the


    future a cash flow will occur, the smaller its
    present value.
    Thus, far-distant dividends have a
    small present value and contribute
    very little to the price of the stock
    While we designate next year’s dividend in the formula, this is just to
    be consistent with the later models. Since there is no growth, all the
    dividends are the same regardless of which year we are referring to.
    SAMPLE

    Consider the following example with a preferred


    stock. Assuming that a preferred stock has a par
    value of $75, pays a 10% dividend and you have an
    8% required return, what is this stock worth to you?
    SAMPLE

    Consider the following example with a preferred


    stock. Assuming that a preferred stock has a par
    value of $75, pays a 10% dividend and you have an
    8% required return, what is this stock worth to you?
    CONSTANT GROWTH – ( GORDON
    GROWTH MODEL – GGM)
     While it is possible for a common stock to have a constant dividend over
    time, it is not likely. Companies tend to grow and expand, which usually
    results in dividends growing over time. However, if dividends don’t remain
    constant we can no longer use a perpetuity formula.

     The Gordon growth model (GGM) assumes that a company exists forever and
    that there is a constant growth in dividends when valuing a company's stock.

     The GGM works by taking an infinite series of dividends per share and
    discounting them back into the present using the required rate of return .
    SAMPLE

     Fora quick example, consider a stock that just


    paid a dividend (D0) of $5.00 per share with
    dividends growing at a constant 4% per year. If my
    required return is 13%, what is the stock worth to
    me?
    SAMPLE
     For a quick example, consider a stock that just paid a
    dividend (D0) of $5.00 per share with dividends growing at
    a constant 4% per year. If my required return is 13%, what
    is the stock worth to me?
    LIMITATIONS
     Growth rates rarely remain constant over time. However if growth
    rates are relatively stable, this can be a close approximation.

     This model only works when the required return exceeds the growth
    rate. This is not usually critical as it is impossible to maintain a growth
    rate higher than the required return indefinitely, but if you try
    applying this model when the growth rate exceeds the required return,
    you will get a negative value – which does not make sense as stock
    prices will not fall below $0.00 due to the limited liability concept
    Supernormal (Non-Constant) Growth

    This is where things get a little


    tricky. However, it is the most
    common situation. The solution is
    not a simple formula, but instead a
    three-step process.
    The 3-Step Solution
     Step 1 – Forecast the dividends during the non-constant growth
    period up to the first year at which dividends grow at a constant
    rate.

     Step 2 – Once a constant growth rate is reached, use the constant


    growth pricing model to forecast the stock price. This stock price
    represents the PV of all dividends beyond the non-constant growth
    period.

     Step 3 – Discount the cash flows (dividends found in step one and
    price found in step two) back to year zero at the appropriate
    discount rate. This is the current value of the stock.
    SEATWORK – BY PAIR

    Consider a firm that just paid a dividend of $2.60.


    They plan to increase dividends by 5% in year one,
    10% in year two, 20% in year three, 20% in year
    four, and then 3% per year thereafter. You feel
    that a 16% required return is appropriate. What is
    this stock worth to you?
    SOLUTION
    CONCLUSION
    The dividend discount model is one of the most basic techniques
    of absolute stock valuation. The DDM is based on the assumption
    that the company’s dividends represent the company’s cash flow
    to its shareholders.

    Essentially, the model states that the intrinsic value of the


    company’s stock price equals the present value of the company’s
    future dividends. Note that the dividend discount model is
    applicable only if a company distributes dividends regularly and
    the distribution is predictable.
    Discounted Cash Flow Model (DCF)

    The discounted cash flow model is another popular method of


    absolute stock valuation. Under the DCF approach, the intrinsic
    value of a stock is calculated by discounting the company’s free
    cash flows to its present value.

    The main advantage of the DCF model is that it does not require any
    assumptions regarding the distribution of dividends. Thus, it is
    suitable for companies with unknown or unpredictable dividend
    distributions. However, the DCF model is more sophisticated from a
    technical perspective.
    Discounted Cash Flow Model (DCF)

     DCF analysis attempts to determine the value of an


    investment today, based on projections of how much money that
    investment will generate in the future.

     It can help those considering whether to acquire a company or buy


    securities make their decisions. Discounted cash flow analysis can
    also assist business owners and managers in making capital
    budgeting or operating expenditures decisions.
    STEP BY STEP PROCESS

    1. Make a projections of the expected future cash flows.


    2. Discount such cash flows using the appropriate discount rate (WACC) to get
    the enterprise value.
    3. Deduct the firm’s debt from the enterprise value to get the Fair Value of the
    Equity component.
    4. Divide such fair value by the total outstanding shares and compare it to the
    prevailing market price.
    5. Decide if the stock is worth buying. Depending if it is underpriced or
    overpriced.
    OTHER USE OF DCF
    ADVANTAGES

     Discounted cash flow analysis can provide investors and


    companies with an idea of whether a proposed investment is
    worthwhile.
     It is analysis that can be applied to a variety of investments and
    capital projects where future cash flows can be reasonably
    estimated.
     Its projections can be tweaked to provide different results for
    various what if scenarios. This can help users account for
    different projections that might be possible.
    DISADVANTAGES

     Once you have a system for evaluating whole businesses or individual stocks or
    projects or whatever your application may be, the math is easy. The hard part is
    predicting the future.
     The major limitation of discounted cash flow analysis is that it involves estimates,
    not actual figures. So the result of DCF is also an estimate. That means that for DCF
    to be useful, individual investors and companies must estimate a discount rate and
    cash flows correctly.
     Furthermore, future cash flows rely on a variety of factors, such as market demand,
    the status of the economy, technology, competition, and unforeseen threats or
    opportunities. These can't be quantified exactly. Investors must understand this
    inherent drawback for their decision-making.
    KEY TAKEAWAYS

     Discounted cash flow analysis helps to determine the value of an


    investment based on its future cash flows.

     The present value of expected future cash flows is arrived at by using a


    projected discount rate. – usually WACC

     If the DCF is higher than the current cost of the investment, the
    opportunity could result in positive returns and may be worthwhile.
    KEY TAKEAWAYS
     Companies typically use the weighted average cost of
    capital (WACC) for the discount rate because it accounts
    for the rate of return expected by shareholders.

     A disadvantage of DCF is its reliance on estimations of


    future cash flows, which could prove inaccurate.

    You might also like