Chapter 9 - Stock Valuation

1. Dividends 2. Capital gains

A stock provides what two kinds of cash flows?

High

Companies with opportunities to invest in projects with large, positive NPVs are likely to have _____________ (high/low) PE ratios.

Net income / # shares outstanding

EPS formula

1. Choose a benchmark stock or stocks 2. Estimate the multiple (EV or PE) for the benchmark 3. Multiply the benchmark multiple by the expected earnings of the company to estimate its intrinsic value

How does one compute multiples?

Earnings Growth

If there is NO reinvestment, there will be NO what?

PN = DIV N+1 / (R - g) = DIV0 (1 + g)^N+1 / (R-g) Where DIVN+1 is dividend in the first year AFTER year N **remember this varies for differential growth

REVIEW OF TIMING: The price of stock in N years PN = what? WRITE this down

P0 = DIV 1 / (R - g) = DIV0 (1 + g) / (R - g) Where DIV1 is dividend in the first year AFTER year 0

REVIEW OF TIMING: The price of stock in year 0 P0 = what? WRITE this down

Perpetuity (Div / R)

Since future cash flows are constant, the value of a zero growth stock is the PV of a what?

Growing perpetuity

Since future cash flows grow at a constant rate forever, the value of a constant growth stock is the present value of a what?

True

T/F: As with PE ratios, it is generally assumed that similar firms have similar EV/EBITDA ratios

True

T/F: Similar firms have similar PE ratios

Present Value of its expected future cash flows

The (intrinsic) value of any asset or firm is what?

1. Dividend Yield 2. Capital gains yield or growth rate

The Gordon growth model (expected equity return) states R in terms of what two components?

equity

The PE ratio focuses on ________________, but market value ratios focus on the actual value of the firm.

positively

The PE ratio is _____________________ related to growth opportunities.

negatively

The PE ratio is _____________________ related to the stock's risk.

Constant growth

The __________________________________ dividend model assumes that dividends will grow at a constant rate, g, forever.

Differential Growth

The _____________________________________ dividend model assumes that dividends will grow at different rates in the foreseeable future and then will grow a constant rate thereafter.

Stock price's

The dividend growth rate is also the _________________________ growth rate.

Growth rate in dividends

The estimate for the growth rate in earnings (g), is also the estimate for the ________________________________ ______________________ under the common assumption that the ratio of dividends to earnings is held constant.

R (required/expected rate of return)

The expected equity return (aka Gordon growth model) states the constant growth model in terms of what?

Capital gains yield

The growth rate (g) can be interpreted as the ___________________________________; that is, the rate at which the value of the investment grows

Fundamental Value

The intrinsic value is also called what?

1. Zero growth 2. Constant Growth 3. Differential Growth

What are the 3 different types of stock valuation using dividends?

1. Dividend discount model 2. Comparables 3. The firm cash flow model

What are the 3 ways discussed on how to determine the value of a share of stock?

1. PE ratio (price to earnings) 2. EV ratio (Enterprise Value)

What are the two comparables/multiples used when valuing stocks?

Intrinsic value is an estimate of the actual true value of a company. Market value is the value of a company as reflected by the company's stock price.

What is the difference between intrinsic value and market value?

Div / Po

What is the formula for the dividend yield?

high-tech (unlike companies like railroad, steel, etc.)

________________________ stock generally sell at high PE ratios because they are perceived to have many valuable projects and therefore perceived to have high growth rates

Price-to-earnings ratio (PE ratio)

A stock's __________________________________ is the ratio of the stock's price to its earnings per share OR the market cap of firm divided by earnings

There is NO best method. However, if the benchmark is well-chosen, perhaps the comparables method would be best. But, if we were very sure of the growth rate of cash flows, perhaps the constant growth method would be best. In practice, both methods are used.

Between the constant growth method and the benchmark (comparables) method which is best?

earnings

Like PE, we compare the EV to a measure of ________________. From a firm level, this is EBITDA, or earnings before interest, taxes, depreciation, and amortization. (EBITDA represents a measure of total firm cash flow)

(Price per share)(# shares outstanding)

Market Cap formula

Zero growth

The __________________________ dividend model assumed that dividends will remain at the same level forever.

Comparables

These are used to value companies based primarily on multiples.

The PV of all of the expected future dividends

The price of a share of common stock is equal to what?

As the current stock price divided by annual EPS OR the market cap of firm divided by earnings

The price-earnings ratio is calculated how? (2 ways)

Dividend Yield and expected growth rate, g, (which is the capital gains yield) R = Dividend yield + Capital gains yield R = Div/Po + g

The required return rate (R) has what two components? (think of the Gordon Growth Model)

growth rate (g) and discount rate (R)

The value of a firm is a function of what 2 things?