                     Learning Objectives  Common Stock Valuation  Dividend Growth model  Zero Growth  Constant Growth  Multiple growth model  Intrinsic Value & Market price  Relative Valuation Techniques (P/E,P/S,P/S)  Components of Required Return   Fixed Income (Bonds)  Treasuries  Corporates  Equities  Preferred Stock  Common Stock  It is an equity ownership in a corporation, initially issued to raise capital Points to keep in mind!  C/F’s are NOT known in advance  Life of stocks is forever – no maturity  Difficult to observe required rate of return for discounting  The two approaches to valuing common stock using fundamental security analysis are: 1. Discounted Cash flow techniques 2. Relative valuation techniques  The two approaches to valuing common stocks using fundamental security analysis are: 1. Discounted Cash flow techniques Attempts to estimate the value of a stock today using a present value analysis. 2. Relative valuation techniques A stock is valued relative to other stocks based on the basis of ratios. Key difference!  !" #$ The estimated value of a security is equal to the discounted value (Present Value) of the future stream of cash flows that an investor expects to receive from the security: Estimated Value of any security = V 0 V 0 = Expected Cash Flows/ (1 + K) t Where: K is the appropriated Discount Rate  !" #$ To use Discounted Cash flow Model, an investor must: 1. Estimate the amount & timing of future stream of Cash flows. 2. Estimate an appropriate Discount Rate 3. Use these two components in PV Model to estimate the value of the security, which is then compared to the current Market Price of the security.  !" #$ Two different approaches to the cash flows & discount rates can be used in the valuation of stocks: 1. Value the Equity of the Firm, using the required rate of Return to shareholders. 2. Value the entire firm using the Weighted Average Cost of Capital (WACC). [...]... = 50.50 P4 Investments BSC/BBA III Winter Semester 2010 Lahore School of Economics Investments Chap 10 Common Stock Valuation Common Stock Valuation Learning Objectives  Common Stock Valuation  Dividend Growth model  Zero Growth  Constant Growth  Multiple growth model  Intrinsic Value & Market price  Relative Valuation Techniques (P/E,P/S,P/S)  Components of Required Return Dividend discount... Dividend equal to the current Dividend, Do So, Value of the stock is a Present value of a Perpetuity! Po = D/K The Zero Growth rate modelExample A company pays a dividend of $2 per share, which is not expected to change Required return is 20% What’s the price per share today? Discounted Cash Flow Techniques – Zero Growth - Example A company pays a dividend of $2 per share, which is not expected to change...Discounted Cash Flow Techniques How to come up with the Price of a Stock? Assumptions:  Assume a dividend the stock will pay  Assume a selling price at the end of 1 year  Come up with a required rate of return Discounted Cash Flow Techniques - Example Example: Stock selling price after 1 year is $70 Stock dividend will be $10 Investors... [P2/(1+K)2] Dividend Discount Model Formula: Po = E [Dn/ (1+K)n] Present Value of all future dividends as a general valuation framework! Dividend Discount Model Investors must value a stream of dividends that may be paid forever, since common stock has no maturity value 1 The dividend Stream is uncertain: 2   There is no specified number of dividends, if in fact any are paid at all Dividends are Expected to... Price with constant growth dividends: Po = Do *(1+g) / (K-g) P0 = D1 / (K – g) OR Dividend Discount Model Assumptions  Dividend paying stock  Required Return by investors is greater than the Growth Rate of Dividends  Dividends will grow at a constant Rate forever The Constant Growth Rate Model example Suppose Do = 2.30, K=13%, g=5% What’s the price per share? The Constant Growth Rate Model example Suppose... Return Dividend discount models -Multiple Growth Rate Case For many companies, it is inappropriate to assume that dividends will grow at a constant rate as Firms typically go through life cycles P0 = PV of Expected Future Cash flows . estimated value of a security is equal to the discounted value (Present Value) of the future stream of cash flows that an investor expects to receive from the security: Estimated Value of any security. Estimate the amount & timing of future stream of Cash flows. 2. Estimate an appropriate Discount Rate 3. Use these two components in PV Model to estimate the value of the security, which is then. Price of the security.  !" #$ Two different approaches to the cash flows & discount rates can be used in the valuation of stocks: 1. Value the Equity of the