Valuing stocks
total payout and free cash flow valuation models: if the firm undertakes share repurchases, it is more reliable to use which model to value the firm?
total payout model
valuation based on comparable firms: we can also value stocks by using valuation multiples based on comparable firms multiples commonly used for this purpose include what?
P/E ratio ratio of enterprise value to EBITDA
total payout and free cash flow valuation models: when a firm has leverage, it is more reliable to use what model?
discounted free cash flow model
total payout and free cash flow valuation models: in the total payout model, the value of equity = ......................
value of equity = PV of future total dividends and repurchases
total payout and free cash flow valuation models: in the discounted free cash flow model, Free cash flow = ....................
Free cash flow = EBIT x (1 - tc) - net investment - increases in net working capital net investment = firm's capital expenditures in excess of depreciation
valuation based on comparable firms: using multiples assumes what?
assumes that comparable firms have the same risk and future growth as the firm being valued
applying the dividend discount model: the constant dividend growth model assumes what?
assumes that dividends grow at a constant expected rate g. in that case, g is also the expected capital gain rate P0 = Div1/rE - g
total payout and free cash flow valuation models: how can we estimate a terminal enterprise value?
by assuming free cash flows grows at a constant rate (typically equal to the rate of long run revenue growth)
total payout and free cash flow valuation models: we discount cash flows using what?
discount cash flows using the weighted average cost of capital
The Dividend-discount model: the law of one price states that the value of a stock is equal to the present value of the dividends and future sale price the investor will receive Because these cash flows are risky they must be .......................
discounted at the equity cost of capital, which is the expected return of other securities available in the market with equivalent risk to the firm's equity
total payout and free cash flow valuation models: to determine the stock price, what do we do?
divide the equity value by the initial number of shares outstanding P0 = PV (Future total dividends and repurchases) / shares outstanding
applying the dividend discount model: if the firm has a long term growth rate of g after the period N+1 then we can apply the ............................... and use the .......................... formula to estimate the terminal stock value Pn.
dividend discount model constant dividend growth formula
applying the dividend discount model: future dividends depend on what?
earnings, shares outstanding and the dividend payout rate Divt = (Earningst / shares outstanding) or EPS x Dividend payout rate Divt = EPS x Dividend payout rate
information, competition and stock prices: competition between investors tends to eliminate what?
eliminate positive NPV trading opportunities
The Dividend-discount model: the expected total return of a stock should equal what?
equal its equity cost of capital
The Dividend-discount model: the total return of a stock is equal to what?
equal to the dividend yield plus the capital gain rate
total payout and free cash flow valuation models: the firm's enterprise value (market value of equity + debt, less excess cash) equals what?
equals the PV of the firm's future free cash flow V0 = PV (future free cash flow of the firm)
applying the dividend discount model: if the dividend payout rate and the number of shares outstanding is constant, and if earnings change only as a result of new investment from retained earnings, then the growth rate of the firm's earnings, dividends, and share price is calculated as what? g = ......................................
g = retention rate x return on new investment
information, competition and stock prices: privately informed traders may be able to profit from their information, which is reflected in prices only ...............
gradually
total payout and free cash flow valuation models: the growth rate of the firm's total payout is governed by what?
growth rate of earnings, not earnings per share
applying the dividend discount model: cutting the firm's dividend to increase investment will raise the stock if, and only if ......................
if the new investments have a positive NPV
The Dividend-discount model: if the stock eventually pays dividends and is never acquired the dividend discount model implies what?
implies that the stock price equals the present value of all future dividends
information, competition and stock prices: competition will be strongest when information is .............
public and easy to interpret
The Dividend-discount model: the expected total return of a stock should equal its equity cost of capital what is the formula?
rE = ((Div1 + P1/ P0) - 1) = (Div1 / P0) + (P1-P0/P0) (Div1/P0) = Dividend yield (P1-P0/P0) = Capital gain rate
The Dividend-discount model: When investors have the same beliefs, the dividend discount model states what?
states that for any horizon N, the stock price satisfies the following equation P0 = (Div1/1+rE) + (Div2/(1+rE)^2) + DivN/(1+rE)^n + Pn / (1+Re)^N
The Dividend-discount model: what is the law of one price?
states that the value of a stock is equal to the present value of the dividends and future sale price the investor will receive
total payout and free cash flow valuation models: how do we determine the stock price?
subtracting debt and adding cash to the enterprise value and then dividing by initial number of shares outstanding P0 = V0 + Cash0 - Debt0 / Shares outstanding
information, competition and stock prices: stock prices aggregate the information of many investors. therefore, if our valuation disagrees with the stock's market price, it is most likely an indication of what?
that our assumptions about the firm's cash flows are wrong
applying the dividend discount model: the dividend discount model is sensitive to what?
the dividend growth rate which is difficult to estimate accurately
total payout and free cash flow valuation models: WACC is what?
the expected return the firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together
