Stock Valuations

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Stock Valuations
Randy Richter Tyler
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Use multiple research options

• These options can be a mix of fundamental
  analysis, statistical analysis, and valuation
  models
• Dont rely on one model or analysis just because
  of the favorable outcome
• Forecasted numbers play a significant role

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Required Rate of Return

• All valuations depend on an investors toleration
  for risk and demand of a certain return
• Historical data is needed for values used in
  valuation equations

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The Future

• The balance of using valuations is to weigh how
  much the future will resemble past data
• The accuracy of your valuations depend on how
  accurate your forecasted values are

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Steps in Valuation Process

• 1. Forecast numbers
• 2. Determine investment horizon and corresponding
  data length
• 3. Compute valuation equations

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CAPM

• ri rf bi x (rm-rf)
• riRequired Return on Investment
• rfRisk-free Rate
• biBeta for Investment
• rmMarket Return
• rfRisk-free Rate

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Example

• We will solve for our required rate of return.
• Universal Office has beta of 1.3, risk-free rate
  is 5.5, expected market return of 15

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Example cont.

• ri rf bi x (rm-rf)
• Ri5.51.3 x (15-5.5)
• Our required rate of return is 17.85 for this
  investment using the CAPM
• If we believe that this return is too low for the
  risk we are taking, then we would try to avoid
  this investment

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Variables

• Remember you are using past data, so you can
  account for variables that might occur in the
  future
• Any valuations used right now are probably going
  to be out of wack because of the unprecedented
  time we are going through.
• You might want to use data over a long period of
  time to smooth out this volatile time

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Dividend Valuation Model

• Very basic valuation assumes same dividend each
  year
• Value of share of stockAnnual dividend/Required
  rate of return

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Constant-growth model

• A little bit more complicated allows for changes
  in dividends
• Value of share of stockNext years
  dividends/(Required rate of return-Constant rate
  of growth in dividend)

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Dividend-and-Earnings Approach

• Takes into account dividends and capital gains
• V(D1PVIF1)(D2PVIF2)(DnPVIFnSPn)
• Dfuture dividend
• PVIFpresent-value interest factor
• SPnestimated share price, year n
• Nnumber of investment horizon years

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Example in book

• Forecasted numbers in book using this formula
  sales from preceding yeargrowth rate in
  salesgrowth in salessales from preceding
  yearforecast

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Example continued

• 3-year investment horizon, required rate of
  return of 18, and forecasted div. and share
  price from table 8.3
• (0.18.847)(.24.718)(.28.609)
  93.20.609)57.25
• Forecasted share price after 3 years57.25

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What if the stock doesnt give out dividends.
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Example

• 2 year investment horizon, forecasted share price
  of 70, and 15 required rate of return
• Share pricePVIFV
• 70.75652.92

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Other approaches

• P/E approach
• Stock priceEPSP/E ratio
• Some stocks dont provide P/E ratio, so you might
  be limited with this approach

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Other approaches

• Market price/cash flow per share
• Cash flow per shareEBITDA/shares outstanding
• P/S ratio lowgood
• Market price/sales per share

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Other approaches

• P/BV ratiomarket price/book value per share
• If P/BV ratio is 7-8x, good chance it is
  overvalued