Stock Valuation

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Stock Valuation

• Jeff Cahn Tom Mrjenovich

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Why Own Common Stock?

• Capital Gains Increase in stocks price
• Dividends Monthly, quarterly, or yearly payouts
  of a corporations earnings.
• Not all corporations pay dividends

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Valuation

• The stocks price is the present value of the
  expected future dividends plus the present value
  of any capital gains.

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Dividend Discount Models

• Zero-Growth Model
• Constant-Growth Model
• Multiple-Growth Model

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Zero-Growth Model

• Assumption- Future dividend payouts remain
  constant
• Infinite Holding Period
• VD1 / k
• Finite Holding Period
• V D1 / (1k) D2 / (1k)2 DtPt/ (1k)t
• V price of stock, D0 Previous years dividends,
  Dn future dividends, k discount rate, g
  dividend growth rate.

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Example 1

• You want to buy xyz corporations stock today. You
  plan to sell it in 2 years. It will pay a
  dividend of 2.00 per year over the next two
  years (at the end of each year). The stock price
  at the end of year 2 will be 15.00. The discount
  rate is 8, how much should you pay for the stock?

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Solution 1

• V D1 / (1k) D2P2 / (1k)2
• V
• V

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Constant Growth Model

• Assumption- Future dividend payouts grow at a
  constant rate.
• Infinite holding period
• VD1 / (k-g)
• Finite holding period
• V D1/ (1k) (D1(1g)t-1 ) / (1k)t
  D1(1g) t-1Pt/ (1k)t

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Example 2

• You want to buy xyz corporation today. XYZ
  corporation paid a dividend of 2.00 yesterday.
  Assuming their dividend will grow 2 per year
  forever and a discount rate 8, what is a fair
  price?

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Solution 2

• VD1 / (k-g)
• D1 D0(1g)
• V
• V

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Multiple-Growth Model

• Assumption- forecast dividends for the first few
  years until you believe they will grow at a
  constant rate.
• T
• VS D1 / (1k)t DT1 / (k-g)(1k)t
• t1

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Example 3

• You want to buy xyz corporation stock today. You
  forecast they will pay a dividend of 2.00 in
  year 1, 1.50 in year 2, and 3.00 in year 3.
  From year 3 onwards they will have a growth rate
  of 2 and a discount rate of 8. What would you
  be willing to pay?

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Solution 3

• T
• VS D1 / (1k)t DT1 / (k-g)(1k)t
• t1
• V
• V

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Questions?