Chapter 8 - Stock Valuation
Common Stock
Equity without priority for dividends or bankruptcy.
Constant Dividend Growth model ("Gordon Growth Model")
Growing perpetuity P0=D1/(R-g)
Price of a stock
Present value of all expected future cash flows
Stock Valuation Using Multiples
Pt = Benchmark PE ratio * EPSt The benchmark PE ratio is often an industry average or based on a company's own historical values.
Preemptive right
Right of first refusal to buy new stock issue to maintain proportional ownership if desired
Features of Common Stock (rights)
Share proportionally in declared dividends Share proportionally in remaining assets during liquidation Right to vote on matters of great importance i.e. merger
Zero growth Dividend model
Simple perpetuity P0=D/R
Classes of stock
Some firms have multiple classes of stock. Typically different share classes have different voting rights
NYSE (New York Stock Exchange)
The world's largest physical stock exchange. Auction market (therefore physical location) Perception is less volatile, blue-chip companies Most buys and sells are matched electronically nowadays Members: Designated Market Maker Floor Broker Supplemental Liquidity Providers
Auction (Broker)
connects buyers to sellers in a physical location. (think real estate agent)
Proxy
grant of authority by a shareholder allowing another individual to vote his or her shares
Constant Growth Model Conditions
1) Dividend expected to grow at g forever 2) Stock price expected to grow at g forever 3) Expected dividend yield is constant 4) Expected capital gains yield is constant and equal to g 5) Expected total return, R, must be > g 6) Expected total return (R): = expected dividend yield (DY) + expected growth rate (g) = dividend yield + g
Cash flows to shareholders
1) Dividends (cash income) 2) Sell shares to another investor or back to the company (capital gains)
Required return
Can rearrange DGM model to get R=D1/P0 + g D1/P0 is called the dividend yield g is called capital gains (can show is equivalent to expected growth rate of the stock)
NASDAQ
Computer based quotation system (no physical exchange) Dealer market (with technology more matching of buyers and sellers today) Market makers act similarly to NYSE DMMs (except there exist multiple market makers for stocks) Large portion of technology stocks (and IPOs).
Supplemental liquidity providers (SLPs)
Investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (i.e., offering to either buy or sell). They trade purely for their own accounts.
Designated Market Maker (DMM)
NYSE members who act as dealers in particular stocks. Formerly known as "specialists"
Floor Broker
NYSE members who execute customer buy and sell orders
Nonconstant growth model
Some growth rate for x years before a constant growth rate indefinitely. Use TVM skills to find the value. Take the present value of all expected future cash flows. Step 1) Discount nonconstant growth period Step 2) Find price for constant growth period Step 3) Discount price in step 2 back to the present Step 4) Sum all PVs
Preferred Stock
Stock with dividend priority over common stock Dividends - Must be paid before dividends can be paid to common stockholders - Not a liability of the firm - Can be deferred indefinitely - Most preferred dividends are cumulative - Missed preferred dividends have to be paid before common dividends can be paid Preferred stock generally does not carry voting rights
Common Stock and voting
Voting rights: generally "one share = one vote" Types of voting: 1) Straight voting 2) Cumulative voting Elections are typically staggered
Proxy fight
When an "outside" group of shareholders attempt to remove directors/management.
Dealer Market
maintains an inventory and stands ready to buy and sell at any time. (think about used car lot)
Primary market
market in which new securities are originally sold to investors. (IPO market)
Secondary Market
market in which previously issued securities are traded among investors
