Fundamentals of Equity Valuation: Models and Analysis Techniques
This chapter discusses the various models and techniques used for equity valuation. The chapter begins with an overview of the basic types of models used, including balance sheet models, dividend discount
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PowerPoint presentation about 'Fundamentals of Equity Valuation: Models and Analysis Techniques'. This presentation describes the topic on This chapter discusses the various models and techniques used for equity valuation. The chapter begins with an overview of the basic types of models used, including balance sheet models, dividend discount. The key topics included in this slideshow are . Download this presentation absolutely free.
Slide111 Chapter 13 Equity Valuation
Slide222 Fundamental Stock Analysis: Models of Equity Valuation Basic Types of Models Balance Sheet Models Dividend Discount Models Price/Earning Ratios Estimating Growth Rates and Opportunities
Slide333 Intrinsic Value and Market Price Intrinsic Value Self assigned Value Variety of models are used for estimation Market Price Consensus value of all potential traders Trading Signal IV > MP Buy IV < MP Sell or Short Sell IV = MP Hold or Fairly Priced
Slide444 4 Dividend Discount Models: General Model V D k o t t t ( ) 1 1 V 0 = Value of Stock D t = Dividend k = required return
Slide555 5 No Growth Model V D k o Stocks that have earnings and dividends that are expected to remain constant Preferred Stock
Slide666 6 No Growth Model: Example E 1 = D 1 = $5.00 k = .15 V 0 = $5.00 / .15 = $33.33 V D k o
Slide777 Exercise in class Suppose stock is expected to pay a $0.50 dividend every quarter and the required return is 10% with quarterly compounding. What is the price?
Slide888 8 Constant Growth Model Vo D g k g o ( ) 1 g = constant perpetual growth rate
Slide999 9 Constant Growth Model: Example Vo D g k g o ( ) 1 E 1 = $5.00 b = 40% k = 15% g = 8% V 0 = 3/(.15-.08) = 42.86.
Slide101010 Exercise in class Suppose Big D, Inc. just paid a dividend of $.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk, how much should the stock be selling for?
Slide111111 11 Estimating Dividend Growth Rates g ROE b g = growth rate in dividends ROE = Return on Equity for the firm b = plowback or retention percentage rate (1- dividend payout percentage rate)
Slide121212 12 Shifting Growth Rate Model V D g k D g k g k o o t t t T T T ( ) ( ) ( ) ( ) ( ) 1 1 1 1 1 1 2 2 g 1 = first growth rate g 2 = second growth rate T = number of periods of growth at g 1
Slide131313 Shifting Growth Rate Model: Example D 0 = $2.00 g 1 = 20% for 3years g 2 = 5% forever k = 15% T = 3 D 1 = 2.40 D 2 = 2.88 D 3 = 3.46 D 4 = 3.63 V 0 = D 1 /(1.15) + D 2 /(1.15) 2 + D 3 /(1.15) 3 + D 4 / (.15 - .05) ( (1.15) 3 V 0 = 2.09 + 2.18 + 2.27 + 23.86 = $30.40
Slide141414 Exercise in class Suppose a firm is expected to increase dividends by 20% in one year and by 15% in the next two years. After that dividends will increase at a rate of 5% per year indefinitely. If the last dividend was $1 and the required return is 20%, what is the price of the stock?
Slide151515 15 Specified Holding Period Model 0 1 1 2 2 1 1 1 V D k D k D P k N N N ( ) ( ) ( ) . . . P N = the expected sales price for the stock at time N N = the specified number of years the stock is expected to be held
Slide161616 Exercise in class 1. Gagliardi Way Corporation has an expected ROE of 15%. Its dividend growth rate will be __________ if it follows a policy of paying 30% of earning in the form of dividends. A) 4.5% B) 10.5% C) 15.0% D) 30.0% 2. Rose Hill Trading Company is expected to have EPS in the upcoming year of $8.00. The expected ROE is 18.0%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 70%, its dividend in the upcoming year should be __________. A) $1.12 B) $1.44 C) $2.40 D) $5.60 3. Rose Hill Trading Company is expected to have EPS in the upcoming year of $6.00. The expected ROE is 18.0%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 70%, its intrinsic value should be __________. A) $20.93 B) $69.77 C) $128.57 D) $150.00
Slide171717 Exercise in class 4. Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year. Dividends are expected to grow at 8% per year. The riskfree rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate, and the constant growth DDM to determine the value of the stock. The stock's current price is $84.00. Using the constant growth DDM, the market capitalization rate is __________. A) 9% B) 12% C) 14% D) 18% 5. Caribou Gold Mining Corporation is expected to pay a dividend of $6 in the upcoming year. Dividends are expected to decline at the rate of 3% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock of Caribou Gold Mining Corporation has a beta of -0.50. Using the constant growth DDM, the intrinsic value of the stock is __________. A) $50.00 B) $150.00 C) $200.00 D) $400.00 6. Lifecycle Motorcycle Company is expected to pay a dividend in year 1 of $2.00, a dividend in year 2 of $3.00, and a dividend in year 3 of $4.00. After year 3, dividends are expected to grow at the rate of 7% per year. An appropriate required return for the stock is 12%. Using the multistage DDM, the stock should be worth __________ today. A) $63.80 B) $65.13 C) $67.98 D) $85.60
Slide181818 18 Partitioning Value: Growth and No Growth Components V E k PVGO PVGO D g k g E k o o 1 1 1 ( ) ( ) PVGO = Present Value of Growth Opportunities E 1 = Earnings Per Share for period 1
Slide191919 Partitioning Value: Example ROE = 20% dy = 60% b = 40% E 1 = $5.00 D 1 = $3.00 k = 15% g = .20 x .40 = .08 or 8%
Slide202020 V NGV PVGO o o 3 15 08 86 5 15 33 86 33 52 (. . ) $42 . . $33 . $42 . $33 . $9 . Partitioning Value: Example V o = value with growth V o = value with growth NGV o = no growth component value NGV o = no growth component value PVGO = Present Value of Growth Opportunities PVGO = Present Value of Growth Opportunities
Slide212121 Price Earnings Ratios P/E Ratios are a function of two factors Required Rates of Return (k) Expected growth in Dividends Uses Relative valuation Extensive Use in industry
Slide222222 22 P/E Ratio: No expected growth P E k P E k 0 1 0 1 1 E 1 - expected earnings for next year E 1 is equal to D 1 under no growth k - required rate of return
Slide232323 23 P/E Ratio with Constant Growth P D k g E b k b ROE P E b k b ROE 0 1 1 0 1 1 1 ( ) ( ) ( ) b = retention ration ROE = Return on Equity
Slide242424 Numerical Example: No Growth E 0 = $2.50 g = 0 k = 12.5% P 0 = D/k = $2.50/.125 = $20.00 PE = 1/k = 1/.125 = 8
Slide252525 Numerical Example with Growth b = 60% ROE = 15% (1-b) = 40% E 1 = $2.50 (1 + (.6)(.15)) = $2.73 D 1 = $2.73 (1-.6) = $1.09 k = 12.5% g = 9% PE=?
Slide262626 Example 223 The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its expected ROE is 12% and its expected EPS is $5.00. If the firm's plow-back ratio is 40%, its P/E ratio will be __________. A) 8.33 B) 11.54 C) 19.23 D) 50.00 Gagliardi Way Corporation has an expected ROE of 15%. Its dividend growth rate will be __________ if it follows a policy of paying 30% of earning in the form of dividends. A) 4.5% B) 10.5% C) 15.0% D) 30.0% Brevik Builders has an expected ROE of 25%. Its dividend growth rate will be __________ if it follows a policy of paying 30% of earning in the form of dividends. A) 5.0% B) 15.0% C) 17.5% D) 45.0%
Slide272727 Example 2223 ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock. At what price would you expect ART to sell? A) $25.00 B) $34.29 C) $42.86 D) none of the above At what P/E ratio would you expect ART to sell? A) 8.33 B) 11.43 C) 14.29 D) none of the above What is the present value of growth opportunities for ART? A) $8.57 B) $9.29 C) $14.29 D) none of the above What price do you expect ART shares to sell for in 4 years? ? A) $53.96 B) $44.95 C) $41.68 D) none of the above
Slide282828 Pitfalls in Using PE Ratios Flexibility in reporting makes choice of earnings difficult Pro forma earnings may give a better measure of operating earnings Problem of too much flexibility
Slide292929 Other Valuation Ratios & Approaches Price-to-book Price-to-cash flow Price-to-sales Present Value of Free Cash Flow Residual Income Model