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    Stock Valuation: by Sarah M. Balisacan, CPA

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    Elise
    The document discusses approaches to valuing common stock, including the dividend growth model, corporate value model, and multiplier models. It then provides examples of applying the constant growth or Gordon growth model, as well as the corporate value model, to calculate the intrinsic value of a stock. Additional topics covered include calculating the required rate of return, growth rate, expected market price, total return, and valuing preferred stock.

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    Stock Valuation: by Sarah M. Balisacan, CPA

    Uploaded by

    Elise
    86 views20 pages
    The document discusses approaches to valuing common stock, including the dividend growth model, corporate value model, and multiplier models. It then provides examples of applying the constant growth or Gordon growth model, as well as the corporate value model, to calculate the intrinsic value of a stock. Additional topics covered include calculating the required rate of return, growth rate, expected market price, total return, and valuing preferred stock.

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    Acctg106_StockValuationPPT.pdf

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    The document discusses approaches to valuing common stock, including the dividend growth model, corporate value model, and multiplier models. It then provides examples of applying the constant growth or Gordon growth model, as well as the corporate value model, to calculate the intrinsic value of a stock. Additional topics covered include calculating the required rate of return, growth rate, expected market price, total return, and valuing preferred stock.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    86 views20 pages

    Stock Valuation: by Sarah M. Balisacan, CPA

    Uploaded by

    Elise
    The document discusses approaches to valuing common stock, including the dividend growth model, corporate value model, and multiplier models. It then provides examples of applying the constant growth or Gordon growth model, as well as the corporate value model, to calculate the intrinsic value of a stock. Additional topics covered include calculating the required rate of return, growth rate, expected market price, total return, and valuing preferred stock.

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    Stock Valuation

    by Sarah M. Balisacan, CPA


    Common Stock
    DEFINITION
     Represent ownership
     Residual claim on assets RIGHTS
    after creditors  Control of the firm
    TYPES  Voting rights
     Classified stock  Pre-emptive right
     Founder’s shares
     Golden shares MARKETS
     Primary market e.g. IPO
     Secondary market
    2
    APPROACHES

     Dividend Growth Model


    o Constant Growth/Gordon Growth
    o Nonconstant/Variable Growth
     Corporate Value Model
     Multiplier Models

    3
    DISCOUNTED DIVIDEND MODEL
    Value of a stock is the present value of expected future dividends.
    ^
    or P 0  D1 1  k s -1  D 2 1  k s -2  ...  D 1  k s -
    ^ D3
    D1 D2 D 
    P0     ... 
    (1  k s ) (1  k s ) (1  k s )
    1 2 3
    (1  k s ) 

    Constant Growth/Gordon Growth Model


    Used for stocks whose dividends are If g is constant, the dividend
    expected to grow forever at a constant growth formula converges:
    rate, g. ^ D 0 (1  g) D1
    1
    D1 = D0 (1+g) P0  
    D2 = D0 (1+g)2 = D1 (1+g) ks - g ks - g
    Dt = D0 (1+g)t = Dt-1 (1+g)
    Cannot be used when ks < g 4
    REQUIRED RATE OF RETURN
    If kRF = 7%, kM = 12%, and β = 1.2, what is the
    required rate of return on the firm’s stock?

    ks = kRF + (kM – kRF)β


    kRF = real rate of return + IP
    MRP = kM – kRF
    ks = 7% + (12% - 7%)1.2
    = 13%

    5
    GROWTH RATE
    A firm has $1,500,000 of assets and
    $500,000 of debt. The expected net income
    is $100,000. If the company plans to pay out
    40% in dividends, how much is the growth
    rate?
    G = Retention Ratio x Return on Equity
    = (1 – DPO) x NI/Equity
    = RE/NI x NI/Equity
    Retention Ratio = (1 - 40%)
    Equity = 1,500,000 - 500,000 = 1,000,000
    ROE = 100,000/1,000,000
    G = 60% x 10% = 6% 6
    BREAK TIME!

    7
    CONSTANT GROWTH OR GORDON GROWTH MODEL

    If D0 = $2 and g is constant 6%, find the expected dividend stream for


    the next 3 years and the stock’s intrinsic value?
    0 g = 6% 1 2 3

    D0 = 2.00 2.12 2.247 2.382


    ^
    D1 $2.12
    D1 = 2 (1+ 6%) P0  
    D2 = 2 (1+6%)2 k s - g 0.13 - 0.06
    or $2.12
      $30.29
    = 2.12 (1+6%) 0.07
    D2 = 2 (1+6%)3
    or
    = 2.247 (1+6%) 8
    EXPECTED MARKET PRICE
    What is the expected market price of the
    stock, one year from now?

    ^
    D2 $2.247
    P1  
    ks - g 0.13 - 0.06
     $32.10
    ^
    P1  P0 (1.06)  $32.10

    Constant growth stocks: Price will grow at


    the same rate as dividends.
    9
    TOTAL RETURN
    What is the dividend yield, capital gains
    yield and total return during the first year?
    Dividend yield = D1 / P0 = $2.12 / $30.29 = 7.0%
    Capital gains yield
    = (P1 – P0)/P0 = ($32.10 - $30.29)/$30.29 = 6.0%
    Total return (ks)
    = Dividend Yield + Capital Gains Yield
    = 7.0% + 6.0% = 13.0%

    Constant growth stocks: Total Return= ks


    CGY = g
    DY = ks - CGY
    10
    NONCONSTANT OR VARIABLE GROWTH
    What if g is 12% in year 1, 10% in year 2, 8% in year 3, and 6% in year 4
    and onwards?
    0 1 2 3 4
    ks = 13%
    ...
    g = 12% g = 10% g = 8% g = 6%
    D0 = 2.00 2.24 2.464 2.661 2.821
    0.885
    1.982
    0.783
    1.929
    0.693
    1.844
    0.693 $ 2.821
    27.928 P3   $40.30
    33.683 $
    = P 0.13 - 0.06
    0
    11
    TOTAL RETURN
    Dividend yield (first year)
    = $2.24 / $33.683 = 6.65%
    Capital gains yield (first year)
    = 13.00% - 6.65% = 6.35%
    During nonconstant growth, dividend yield
    and capital gains yield are not constant, and
    capital gains yield ≠ g.
    After t = 3, the stock has constant growth
    and capital gains yield = 6%, while dividend
    yield = 7%.
    12
    BREAK TIME!

    13
    CORPORATE VALUE MODEL

     Also called the free cash flow method.


    Suggests the value of the entire firm
    equals the present value of the firm’s
    free cash flows.

     FCF = EBIT(1 – Tax Rate) + Dep.


    Expense − CAPEX − Change in WC −
    Change in other assets

    14
    CORPORATE VALUE MODEL
     Find the market value (MV) of the firm.
    o Find PV of firm’s future FCFs

     Subtract MV of firm’s debt and preferred


    stock to get MV of common stock.
    o MV of common stock = MV of firm –
    MV of debt and preferred stock

     Divide MV of common stock by the


    number of shares outstanding to get
    intrinsic stock price (value).
    o P0 = MV of common stock / # of
    shares
    15
    CORPORATE VALUE MODEL

    Assume that today is December 2020, and that the


    following information applies to SA Inc.
     After tax operating income for 2021 is expected to be FCF = 500M + 100M – 200M = $400M
    $500 million.
     The depreciation expense for 2021 is expected to be
    $100 million. $400M
    MVFirm   $10B
     The capital expenditures for 2021 are expected to be 0.10 - 0.06
    $200 million.
     No change is expected in net working capital.
     The free cash flow is expected to grow at a constant MVCommon Stock  $10B - $3B  $7B
    rate of 6% per year.
     The required return on equity is 14%.
     The WACC is 10%. ^
    $7B
     The market value of the company’s debt is $3 billion. P0   $35
     200 million shares are outstanding. 200M
    Using the corporate valuation model approach, what
    should be SA’s stock price today?
    16
    FIRM MULTIPLES

     Analysts often use the following


    multiples to value stocks.
    o P/E
    o P / CF
    o P / Sales

     EXAMPLE: If earnings are $2.45 and the


    appropriate multiple or P/E ratio is 13,
    what is the value of the stock?
    $2.45 x 13 = $31.85

    17
    Preferred Stock
     Hybrid security

     Like bonds, preferred stockholders


    receive a fixed dividend that must be paid
    before dividends are paid to common
    stockholders.

     However, companies can omit preferred


    dividend payments without fear of
    pushing the firm into bankruptcy.

    18
    PREFERRED STOCK
    If preferred stock with an annual
    dividend of $5 sells for $50, what is the
    preferred stock’s expected return?
    D
    P
    kp

    $50 = $5 / kp
    kp = $5 / $50
    = 0.10 = 10%

    19
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    20

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