Ch9 slides fin300

frontier stocks

(new, fledging, aspiring to grow)

p0 = d/r p0 = 5.50 / 0.0775 p0 = 70.97

AAA Company has issued a perpetual PFD stock with a par value of $100 and a dividend of 5.5%. If the Required rate of return is 7.75%, what is the PFD stocks current market price?

dividend yield

Annual dividends received per share//current price of the stock. Thus, a company paying a $2.00 annual dividend when the stock is trading at $40.00 will have a dividend yield of 5%.

4 ways to earn money on your stock investment

Capital gains, dividends, stock buybacks and potentially the company being taken over. In the last scenario, usually the company is taken

´A share of common stock just paid a dividend of $1.00. ´If the expected long run growth rate for this stock is 5.4%, and if investors required a return of 11.4%, what is the stock price?

D1 = 1.00 x (1 + 0.054) = 1.054 P0 = 1.054 / (0.114 - 0.054) = 17.57

´A stock just paid a dividend of $1.50. The RRR is Rs==10.1%. The constant growth rate is 4%. ´ What is the current stock price?

D1 = 1.50 x (1 + 0.04) = 1.56 P0 = D1 / R-g) P0 = 1.56 / (0.101 -0.04) P0 = 25.57

´If Do is $2.25, g (which is constant) is 3.5%, and Po is $50.00, what is the stocks expected dividend yield for the coming year?

D1 = 2.25 x (1+0.035) = 2.32875 P0 = D1 / (R-g) 50 = 2.32875 / (x - 0.035) X = 4.66

dealer

Dealers are intermediaries who have capital and go at risk. Dealers hold inventory and buy and sell in order to make a profit for themselves. A dealer market eliminates the need for time consuming searches for a fair deal because buying and selling take place immediately from the dealers inventory of securities. The OTC market is often set up this way.

The Growth Stock Pricing Paradox

Growth stocks are typically defined as the stocks whose earnings are growing at above average rates and are expected to continue to do so for some time. A company of this type typically pays little or no dividends on its stocks since management would rather invest the FCF into the business. In real life, if you are buying a growth company, you are not necessarily interested in dividends.You want stock appreciation

thinking thematically

If you believe the aging of America story, you would possibly invest in retirement communities, knee and hip replacement companies, pharmaceuticals, etc.

rights offering

In Europe and asia- company trying to raise additional capital via the stock market.

constant growth dividend model

In general, cash dividends do not remain constant but instead grow at some average rate G from one period to the next forever. (From a practical perspective, you want to see the dividend grow since it shows your company is increasing in value and sharing more of its profits with shareholders). P0 = D1 / (R-G)

active management

Iooking to create the outperformance of the market. Looking to beat/ surpass the return of the market

preferred stock

Is PFD stock a stock or a bond? A strong case can be made that PFD stock is a special type of bond rather than equity. Regular PFD stock has no voting rights. PFD stockholders receive a fixed dividend, regardless of the firms earnings and if the firm is liquidated, they receive a stated value (par usually) and not a residual value. Lastly, PFD stocks usually have ratings similar to bond ratings.

D1 = D0 x (1 + g) D1 = 4.45 x (1 + 0.08) D1 = 4.806 P0 = D1 / (R-g) P0 = 4.806 / (0.14 - 0.08) P0 = 80.10

JJ Incorporated just paid a dividend of $4.45. The company has forecasted a dividend growth rate of 8% for the next several years. If the appropriate discount rate is 14%, what is the current price of the stock?

auction

NYSE is the best-known example. On the NYSE, the auction for a security takes place at a specific location on the floor of the exchange, called the POST. The auctioneer in this case is the SPECIALIST, who is designated by the exchange to represent orders placed by public customers. Can be considered the least efficient type of trading. Discuss physical element and advent of technology

Valuing Preferred Stock

PFD stocks are hybrid securities, falling somewhere between stocks and bonds. Some PFD stocks have a defined maturity. Formula: PFD stock price == PV (dividend payments) x PV (par value) Suppose that

N = 15 x 4 = 60 I = ? PV = -95 PMT = 2 per quarter FV = 100 i = 2.15 *this is the quarterly yield. the annual yield is 8.60% (2.15 x 4)

PGE Corporation has a PREFERRED stock issue outstanding that has a stated (par) value of $100. It will be retired from the company in 15 years and pays a dividend of $2.00 per quarter. IF the PFD stock is currently trading at $95 per share, what is the stocks yield to maturity?

Valuing a PFD stock with no maturity

Po ===D //R D is the constant cash dividend R is the discount rate

D1 = D0 x (1+g) D1 = 4.81 x (1 + 0.04) = 5.00 P0 = D1 / (R-G) P0 = 5.00 / (0.18 - 0.04) = 35.71

RBG Incorporated is a regional car parts company in PHX. At the company's financial conference, the CFO announces that the current dividend will be $4.81. The announcement conforms with the company's policy which sets dividend growth at a 4% annual rate. Investors who own stock in similar companies expect to earn a return of 18%. What is the value of the firm's stock?

a stock with a beta of zero (unlikely) is expected to have the return equal to the ________

RF Rate

to bring together buyers and sellers.

The role of the NYSE and NASDAQ and other exchanges is ________ Ideally, they would like to do this as efficiently as possible. In a perfect world, a company's stock price will be near or at its INTRINSIC VALUE.The more efficient the market, the more likely this will occur

common stock valuation

The steps in valuing an asset are; 1. Estimate the expected future cash flows. 2. Determine the required rate of return, or discount rate, which reflects the riskiness of the future cash flows. 3. Compute the PV of the future cash flows to determine what the asset is worth.

first solve for d1 and d0 P0 = D1 / (R-g) 35.25 = D1 / (0.1150 - 0.0475) D1 = 2.394 D1 = D0 x (1 +g) 2.394 = D0 x (1 + 0.0475) D0 = 2.2854 P1 = 35.25 P5 = ? first solve for D6 D6 = D0 x (1 + g)^6 D6 = 2.2854 x (1 + 0.0475)^6 D6 = 3.0192 P5 = D6 / (r-g) P5 = 3.0192 / (0.1150 - 0.0475) = 44.46

WWW Stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 4.75% per year. The Required rate of return on this stock is 11.50%. What is the stocks expected value FIVE years from now?

four types of secondary markets

direct search, broker, dealer, auction

Dividend Discount Model

holds that the value of a share of stock is a function of its future dividends.

p0 = d/r p0 = 5 / 0.08 p0 = 62.50

if Delta Airlines has a perpetual dividend that pays a $5.00 dividend at the end of each year and that investors require an 8% return, the value of the stock will be:

´The primary focus of analysts and investors is to find stocks that have an ________ higher than their current stock value. * every aspect of Disney would have a value

intrinsic value

. Stocks tend to be quite _______ and most large cap stocks are priced efficiently.

liquid

if securities are mispriced, this create a ______ for investors

profit opportunity

cyclical stocks

stocks (companies that are closely aligned with the overall economy--.i.e. CAT, Lennar, Alcoa

Free cash flow to equity is ________

the cash flow that remains after a firm pays all of its expenses and makes necessary investments in working capital and fixed assets. It includes a company's after tax earnings, plus any non cash expenses such as depreciation, minus new investments in working capital and fixed assets.

broker

they bring together buyers and sellers to earn fee, called a commission. Brokers are not passive agents but aggressively seek out buyers or sellers and try to negotiate an acceptable transaction price for their clients. Using another term, they SOURCE LIQUIDITY.

stock buyback

using excess cashflow to buyback stock bc they think the stock is undervalued , and to take supply out of the market-place. The value of the stock will go higher. ´- this doesn't help the employees

formula for constant growth model

v = D1 / (R-G) ´D1 is the annual dividend expected next year (the first year in the forecast period) ´R is the required rate of return ´G is the annual rate of growth in dividends v is the value of a share of stock

passive management

would buy the market/be the risk

fundamental analysis

you analyze all financials of the company to see if the intrinsic value is worth more than the stock price. ´You are looking at financials, cash flow, discount rate to value the cash flows, the firms cost of capital, risk associated with investment, your expected return, micro and macro factors, sector, dividends, etc. ´Needless to say, returns on securities are difficult to predict. You are making educated forecasting guesses.

academic approach

you believe that the markets are efficient, and you will not try to beat the market. You want the market return. You would buy an S and P index fund.

technical analysis

you do not care about fundamentals. You only care about trends, momentum, price points, charts.

it is assumed that the Beta of the entire market is

1

However, common stock valuation is more difficult for several reasons:

1. Common stock dividends are less certain. 2. Common stocks are true perpetuities in that they have no final maturity date. Firms never have to redeem them. 3. Unlike the rate of return, or yield, on bonds, the rate of return on stocks is not directly observable. Thus, grouping common stocks into risk classes is more difficult than grouping bonds.

fundamental, technical, academic approach

3 basic approaches of security analysis of stocks

direct search

: least efficient. Buyers and sellers must seek each other out directly. Common stock of small private companies is a good example of a security that trades in this manner. The VC market is also set up this way to a certain extent. 2.Broker:they bring together buyers

D1 = D0 x (1 + g) D1 = 1 x (1 + 0.054) = 1.054 P0 = D1 / (R-g) P0 = 1.054 / (11.4 - 5.4) P0 = 17.57

A share of common stock just paid a dividend of $1.00. If the expected long run growth rate for this stock is 5.4%, and if investors' required rate of return is 11.4%, what is the stock price?

P0 = D1 / (R-g) P0 = 0.75 / (.105 - 0.064) P0 = 18.29

A stock is expected to pay a dividend of .75 cents at the end of the year. The Required Rate of return is 10.5% and the expected constant growth rate is 6.4% (This is G). What is the stocks current price?

in the CAPM, the risk of the stock is captured by

BETA

CAPM Formula

CAPM : R = Rf + B x (Rm - Rf)

common stock

Common stock represents the basic ownership claim in a corporation. One of the basic rights of the owners to vote on all important matters that affect the company, such as the election of the BOD or a proposed merger or acquisition. Owners of common stock are not guaranteed any dividends and have the lowest priority claim on the firm's assets in the event of a bankruptcy. Common stockholders have limited liability, that is their losses are limited to the original amount of their investment. Common stocks are theoretically perpetuities since they have not expiration dates.

stock splits

Companies often split their stock if it gets to inflated levels that most retail investors cannot afford. ´Example: If a stock is trading at $100 per share and splits 2 for 1, the new trading level is then at $50.00 and a previous owner of 1 share now owns two shares. *know how to calculate^^^

´GGG Inc. is expected to pay a dividend of $1.25 per share at the end of next year. ´The stock sells for $32.50 per share and its required rate of return is 10.5%. The dividend is expected to grow at a constant rate, g, forever.

Equation: P0 = D1 / (R-g) *solve for g: 32.50 = 1.25 / (.105 - g) X(0.105 - g) x(0.105 -g) 3.4125 - 32.50g = 1.25 -3.4125 -3.4125 -32.50g = -2.1625 /-32.50 /-32.50 g = 6.65%

´A stock is expected to pay a dividend of .75 cents at the end of the year. ´ The RRR is Rs ===10.5% and the expected constant growth rate is G ==6.4%. ´ What is the stocks current price?

Equation: P0 = D1 / (R-g) P0 = 0.75 / (0.105 = 0.064) = 18.29

stock spin offs

Example: Time Warner did this several years ago as they morphed into more of a TV/digital company. They spun off Time Inc. This is the creation of a stand-alone company. Generally, you would distribute this to existing shareholders of Time Warner. Example: EBAY spun off Pay Pal about seven years ago. ´Reason for spin off: that the sub is not a good strategic fit for the company, the company has become too diversified or that the sub has more value being a stand alone company.

´Next expected dividend (D1) is $1.60 ´RRR is 11% ´Dividend yield is: D1/Po equals: 6% ´Find the growth rate: g ==Rs -yield equals: 5% ´Find Po ===D1/(Rs -G) equals: $26.67 ´Years in the future: 7 ´P7 is then Po(1 + g)^7 equals: $37.52

SSM Inc. expected year end dividend is D1 equals $1.60. Its required rate of return is 11.00%. Its dividend yield is 6.00% Its growth rate is expected to be constant in the future. What is SSM's expected stock price in 7 years?

defensive stocks

Stocks whose prices remain stable when the economy declines—i.e. Walmart, Dollar Store,

* first solve for D1, then solve for P1, then solve for P5 (to solve for p5 first solve for D6) D1 = d0 x (1 + g) D1 = 2.50 x (1 + 0.05) = 2.625 P1 = D1 / (R-g) P1 = 2.625 / (0.15 - 0.05) = 26.25 P5 = D6 / (R-g) Compute D6 D6 = D0 x (1 + g)^6 D6 = 2.50 x (1 + 0.05)^6 = 3.35 P5 = D6 / (R-g) P5 = 3.35 / (0.15 - 0.05) = 33.50

Suppose that a firm has a current dividend of $2.50. This would be Do. The R is 15%. G is 5% What is the price of the stock today and what will it be in five years (P5)?

n = 20 x 4 = 80 i = 8 / 4 = 2 pv = ? pmt = 10/4 = 2.50 fv = 100 pv = 119.87

Suppose that a utility company's PFD stock has an annual dividend payment of $10.00 (paid quarterly), a stated par value of $100 and a maturity of 20 years. If similar preferred stock issues have market yields of 8%, what is the value of the PFD stock?

Do is 1.84 R is 0.08 G is 0.05 We first compute D1 D1 ==== Do x (1 + G) Equals: 1.84 x 1.05 ====$1.93 Then the value of the share will be: Po ==== D1//R - G $1.93 //0.08 - 0.05 Equals: 1.93 ///0.03 equals: $64.33 second part: First, you must calculate the value of P and G's dividend in year 8. Dividend in year 8 D8 === Do x (1 + G)〖^8〗 ===1.93 x (1.05)〖^8〗 equals: $1.93 x 1.4777 equals: $2.85 Price of a share of P and G in seven years is then: P7 ==== D8//R - G $2.85//0.08 - 0.05 Equals: $2.85 //0.03 ==== $95.00

Suppose that the current cash dividend of P and G is $1.84. Financial analysts on Wall Street believe that the dividend will grow at a constant rate of 5% per year. Investors require an 8% return on stocks with this level of risk. What should be the current price of P and G? second part: What should P and G's stock value be in seven years?

p0 = D/R P0 = 5 / 0.20 = 25 per share

The Gary Company is a printing company based in PHX. Sales and earnings have remained constant over the years. The firm pays a $5.00 dividend per year and the BOD has no plans to change it. If the firm's investors are expecting a 20% return on their investment, what should be the price of the firm's stock?

computing future stock prices

The constant growth dividend model can be modified to determine the value, or price, of a share of stock at any point in time. In general, the price of a share of stock, P1, can be expressed in terms of the dividend in the next period (D1), g and R, when the dividends are expected to grow at a constant rate. Thus the price of a share of stock at time T is as follows: P1 === D1//R - G

balancing

balancing the ratios in your portfolio. Use that gain you made to buy something else and expand your portfolio

PE approach

builds the stock valuation process around the stocks price to earnings ratio. - doesn't rely on dividends to value the company

types of dividends

cash dividends, stock dividends

electronic communication networks (ECNS)

computerized system that automatically matches buy and sell orders for securities in the market.

´VSS Incorporated is a specialty retailer that sells pasta sauce. ´ In 2016, the company generated $2.2 million in after tax earnings. ´VSS took depreciation charges against its fixed assets equal to $250,000 and it invested $50,000 in new working capital and $40,000 in new fixed assets. Thus, the company's free cash flow last year was; ´VSS free cash flow 2016 is:

´$2,200,000 + $250,000 - $50,000 - $40,000 equals: $2,360,000 ´Assuming that the company had 4 million shares outstanding and the firms shareholders expect a 9% rate of return on their investment. ´Suppose that you believe that VSS will continue to generate $2.36 million in free cash flow indefinitely, then....... ´In other words, you would treat the company's free cash flow as a perpetuity, so the PV of the future cash flows would be: ´$2,360,000 //0.09 equals: $26,222,222 ´Given that the company has 4 million shares outstanding, the INTRINSIC value of the company's stock would be: ´$26,222,222//4 million equals: $6.56 per share.

´Total return (in US $)== ´{E94.00 + E5.00// E90.48 x $1.083/$0.945} - 1 ´Equals: {1.0942 x 1.1460} - 1 ´Equals: {1.2540} - 1 =25.4% ´The investor did well but much of the return came from CURRENCY movements, not the behavior of the stock. *TWO OF THESE ON THE FINAL

´A US investor who buys several hundred shares of SIEMENS AG. ´Since Germany is part of the EUROPEAN COMMUNITY, its currency is the EURO. ´Lets assume that the investor paid a price of 90.48 euros per share. ´The exchange rate at the time of the transaction was US$/E of $0.945, meaning that one EURO was worth almost 95 US cents. ´The stock paid dividends of 5 EUROS per share. ´One year later, the stock was trading at 94 Euros, when the US/E exchange rate was $1.083. (Cont.) ´Siemens example continued: ´Clearly, the stock went up and so did the Euro. So the investor must have done alright.

Beta

´A measurement of risk. ´It measures how an asset covaries with the market. ´Example, a stock with a beta of 2.00 should outperform the market (which has a beta of one) but you are taking on additional risk to get that perceived outperformance. Growth companies usually have high betas, more mature, slow growing companies have low betas.

zero growth stock

´Assumes that dividends will not grow over time. ´Value of a share of stock===Annual dividends//Required rate of return ´The value of a zero-growth stock is simply the PV of its annual dividends. P0 = D/R

dividend payout ratio

´Dividends per share//EPS A company would have a payout ratio of 50% if it had earnings of $4.00 a share and paid annual dividends of $2.00 a share. This is a high ratio and most investors are leery that a company can continue to pay such a high percentage. ´Example: ´GE had always paid a generous dividend up until the fiscal crisis. They cut it drastically to save money, increased it slightly as the years have gone by and have since cut it again. Investors do not like when this happens.

´Stock price: $25.00 ´RRR is 11.50% ´Growth rate is 7% ´Po is then: D1//(Rs-G) so D1 is equal to Po(Rs-G) equals: $1.125 ´Last dividend would then be: ´Do ==D1/(1 + G) equals: $1.05

´GGG stock has a RRR of 11.50% ´It sells for $25.00 per share. ´The dividend is expected to grow at a constant rate of 7%. ´What was the last dividend?

value of stock = 3 / 0.10 = 30

´Suppose that a stock pays a dividend of $3.00 per share each year and you don't expect the dividend to change. ´IF you want a 10% return on your investment, how much would you be willing to pay for the stock?

valuation of mature, dividend paying companies that have a long track record of increasing dividends

´The constant growth model is best suited to the ___________ . These are companies that have established dividend policies and fairly predictable growth rates in earnings and dividends.

efficient market hypothesis/theory

´The premise is that securities are rarely, if ever, substantially mispriced in the market. ´No security analysis, however detailed, is capable of consistently identifying mispriced securities with a frequency greater than that which might be expected by random chance alone. In order for EMH to be true, investors must be rational

constant growth model

´The zero growth model is a good beginning, but it does not take into account a growing stream of dividends. ´The constant growth model is the more widely recognized version of the dividend valuation models since it takes into account dividend growth.

converting total returns in a different currency to US currency

´Total returns (In US $) == Current income (dividends) + Capital gains (or losses) + Change in currency rates (P or L) ´Or ´Total return in US dollars == Returns from current income and capital gains (in local currency) + Returns from changes in currency exchange rates (p or L) *will be on exam?

Free cash flow to equity method:

´this estimates the cash flow that a firm generates for common stockholders, whether is pays those out as dividends or not. - doesn't rely on dividends to value the company

negative aspects of stocks

•1. Last to get paid in the event of a bankruptcy. •2. Tend, at times, to be quite volatile. VIX index. Measure of volatility in the marketplace •3. Tend, more often than not, to be quite irrational. •4. No say in how company is run. •5. Could lose all your investment.