Stock Valuation

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Stock Valuation

• Adam Yoder
• Misa Ngo

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Valuation methods

• Discounted Cash Flow Dividends
• Present Value of Growth Opportunities
• P/E ratio Price/ Earnings
• PEG ratio PE/ Growth

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Discounted Cash Flow Model

• Formulas

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DCF example

• Corp A
• Earnings/shr.1
• Book equity/shr.10
• Dividend/shr.0.50
• ROE EPS/ book 10
• Plowback ratio RES / EPS .5

• g ROE Plowback ratio 0.1 0.5 5
• r rf b(rm-rf) 0.05 0.75(0.1 - 0.05)
  8.75

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DCF Practice Question

• Corp. B
• Earnings/shr.3
• Book equity/shr.15
• ROE is 3/15 20
• Dividend/shr.1.75
• Risk free rate 5
• Beta on this stock is 1.25
• SP market return is 10

• g ROE Plowback ratio 0.2 .416 8.3
• r rf b(rm-rf) 0.05 01.25(0.1 - 0.05)
  11.25

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Present Value of Growth Opportunities (PVGO)

• Net present value of a firms future investments
• EPS1/r No-growth capitalized value per share
  (EPS1DIV1, P0DIV1/r)

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Present Value of Growth Opportunities (PVGO)

• Example
• ROE .2
• Payout ratio .6, Plowback ratio .4
• EPS1 5.00, DIV1 3.00, r 15
• Find PVGO?
• P0 DIV1/(r-g)
• P0 EPS1/r PVGO

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Present Value of Growth Opportunities (PVGO)

• Example
• g ROE x Plowback ratio .2 x.4 .8 (8)
• P0 DIV1/(r-g) 3/(.15-.08) 42.86
• No-growth value EPS1/r 5/.15 33.33
• PVGO P0 EPS1/r 42.86-33.33 9.52

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Price/Earnings Ratio (P/E)

• Amount investors are willing to pay for each
  dollar of earnings
• Higher P/E may indicate high growth potential of
  the firm
• Current stock price/annual EPS
• d payout percentage (constant)
• EPS1 next year EPS
• r required rate of return
• g dividend growth rate

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Price/Earnings Ratio (P/E)

• Price of a stock paying dividend D1 at a constant
  growth rate g
• Assume the firm pays out a constant percentage d
  of its earnings E1
• Divide both sides by E1

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Price/Earnings Ratio (P/E)

• Example
• ROE .16
• d .7
• r 16
• Find P/E ratio?
• P0/EPS1d/(r-g)

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Price/Earnings Ratio

• Example
• g ROEx Plowback Ratio ROEx(1-d)
• .16x(1-.7) .048
• P0/EPS1 d/(r-g) .7/(.16-.048) 6.25

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PEG Ratio

• Used by many analysts to determine a valuation
  when a stock has little or no dividend and high
  growth prospects.
• Formulas PEG PE / G
• P0 g PEG EPS
• Traditional thought is a PEG 1 is fairly valued
• Company A
• 2 EPS
• Estimated growth of 15 for next 5 yrs.
• Fair value is 30 per share.

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PEG Ratio

• Recently the PEG ratios have increased
  significantly due to lower discounting rates in
  the T-bills.
• The current SP PEG ratio is around 1.5
• 2 EPS
• Estimated growth of 15 for next 5 yrs.
• Fair value is 45 per share.

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PEG Practice Question

• Company B
• 3 EPS
• 20 growth over next 5 years
• 1.4 Industry average PEG

• Formula P0 g PEG EPS
• P0 20 1.4 3 84

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Questions?