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    13-Common Stocks 2

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    13-Common Stocks 2

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    6 views17 pages

    13-Common Stocks 2

    Uploaded by

    b7tzttpwpd

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 17

    Common Stocks

    What is common stocks

    • Ownership instruments.

    • Issued by the corporations to rais fund for running the business.

    • Purchased by the investors to earn returns.

    • Return volatility is higher than it in bonds, accordingly, they have


    higher standard deviation and higher risk, and higher returns.
    common stocks income

    • Investors (buyers) in common stocks expect returns from two sources.

    • Capital gain (appreciation in stock price).

    • Current income (cash dividends).

    • Some investors rely on capital gain (speculators).

    • Some other rely on cash dividends (long term investors).


    common stocks

    • Have the least priority in payout during liquidation.

    • Have less priority thanthe preffered stock in allocation of dividends.

    • Dividends value determined based on decision from board of directors.

    • High liquid investment due to the availability of active secondary market.

    • Have voting rights in board of directors.


    common stocks

    • To estimate the fair market value for the stock, we need to discount
    future cash flows.

    • So, first we need to determine the future cash flows, then to


    determine the suitable discount rate based on the level of risk.

    • The riskier the investment, the higher the discount rate used.
    The Valuation Process

    • Valuation is a process by which an investor uses risk and return


    concepts to determine the worth of a security.

    • Valuation models help determine what a stock ought to be worth

    • If expected rate of return equals or exceeds our target yield, the


    stock could be a worthwhile investment candidate
    The Valuation Process

    • If the intrinsic worth equals or exceeds the current market value,


    the stock could be a worthwhile investment candidate

    • There is no assurance that actual outcome will match


    expected outcome
    Dividend Valuation Models

    • Zero dividends growth approach (constant dividends approach).

    • Constant dividend growth approach (the dividends grow but at a

    constant rate).

    • Variable dividend growth approach.


    Zero dividends growth approach

    • Uses present value to value stock

    • Assumes stock value is capitalized value of its annual dividends

    • Potential capital gains are really based upon future dividends to be


    received

    • Assumes dividends will not grow over time


    Example 29

    A stock that used to pay $1.2 per stock every year and expected to do
    so for the foreseeable future, if the level of risk for this stick equivalent
    to 11%, what is the intrinsic value (fair market value) for this stock?
    value of the stock =

    D: dividends = 1.2

    i: diccount rate = 0.11

    value of the stock = = = $10.9

    For the same stock if the dividends was $1.5 instead of $1.2 what will
    be the fair price?
    value of the stock = = = $13.6

    The higher the dividends, the higher the stock value, other thing
    constant.

    For the same stock, and if the annual dividends was $1.2 but the
    discount rate is 9%, how much will the fair price be?
    value of the stock = = = $13.3

    The lower the discount rate the higher the stock value, other thing
    constant.
    Constant dividend growth approach

    • Assumes stock value is capitalized value of its annual dividends


    • Assumes dividends will grow at a constant rate over time
    • Works best with established companies with history of steady
    dividend payments
    Example 30

    • A stock already paid $1.75 per stock as annual dividends last year, and
    promises to increase that dividends at 5% every year, if the level of
    risk for this stick equivalent to 12%, what is the intrinsic value (fair
    market value) for this stock?
    Stock value =

    D1 : is the dividends that are going to be paid next year.

    i: the discount rate suitable for this stock.

    g: the growth rate in dividends.

    How to find D1 ?
    D0 = $1.75

    D1 = D0 *

    D1 = 1.75 * 1.05 = 1.84

    Stock value =

    = = = $26.3

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