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Chapter 8: Stocks and Their Valuation.

Chapter 8: Stocks and Their Valuation. Stocks and Their Valuation. Chapter Outline:. Features of Common Stock. Common Stock Valuation. Preferred Stock. Features of Common Stock:. Facts about common stock. Legal Rights and Privileges of Common Stockholders. Types of Common Stock.

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Chapter 8: Stocks and Their Valuation.

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  1. Chapter 8:Stocks and Their Valuation.

  2. Stocks and Their Valuation.

  3. Chapter Outline: • Features of Common Stock. • Common Stock Valuation. • Preferred Stock.

  4. Features of Common Stock: • Facts about common stock. • Legal Rights and Privileges of Common Stockholders. • Types of Common Stock. • The Market for Common Stock.

  5. Facts about common stock: • Represents ownership • Ownership implies control • Stockholders elect directors • Directors elect management • Management’s goal: Maximize the stock price

  6. Legal Rights and Privileges of Common Stockholders: • Control of the Firm. • Voting Rights • Preemptive rights • Right of access to meeting minutes and lists of existing shareholders • Right to vote on issues that affect the firm’s property as a whole

  7. Legal Rights and Privileges of Common Stockholders: • Proxy. • Proxy Fight. • Takeover.

  8. Types of Common Stock: • Classified stock has special provisions. • Could classify existing stock as founders’ shares, with voting rights but dividend restrictions. • New shares might be called “Class A” shares, with voting restrictions but full dividend rights.

  9. Types of Common Stock: • Classified Stock. • Founders Shares.

  10. The Market for Common Stock: • Closely Held Corporation. • Publicly Owned Corporation. • Secondary market. • Primary market. • going public. • Initial public offering market (IPO).

  11. Common Stock Valuation: • Dividend Growth Model. • Corporate Value Model. • Using the Multiples of Comparable Firms.

  12. Dividend Growth Model: • Expected Dividends as the Basis for Stock Values. • Stock Values with Zero Growth. • Normal, or Constant, Growth (Gordon Model). • Expected Rate of Return on a Constant Growth Stock. • Valuing Stocks with Nonconstant Growth.

  13. Expected Dividends as the Basis for Stock Values: • If you hold a stock forever, all you receive is the dividend payments. • The value of the stock today is the present value of the future dividend payments.

  14. Expected Dividends as the Basis for Stock Values:

  15. Stock Values with Zero Growth: AZero Growth Stockis a common stock whose future dividends are not expected to grow at all.

  16. Constant Growth Stock (Gordon Model): • A stock whose dividends are expected to grow forever at a constant rate, g. D1 = D0 (1+g)1 D2 = D0 (1+g)2 Dt = D0 (1+g)t • If g is constant, the dividend growth formula converges to:

  17. What is the stock’s market value? • Using the constant growth model:

  18. What is the expected market price of the stock, one year from now? • D1 will have been paid out already. So, P1 is the present value (as of year 1) of D2, D3, D4, etc. • Could also find expected P1 as:

  19. What is the expected dividend yield, capital gains yield, and total return during the first year? • Dividend yield = D1 / P0 = $2.12 / $30.29 = 7.0% • Capital gains yield = (P1 – P0) / P0 = ($32.10 - $30.29) / $30.29 = 6.0% • Total return (ks) = Dividend Yield + Capital Gains Yield = 7.0% + 6.0% = 13.0%

  20. What happens if g > ks? • If g > ks, the constant growth formula leads to a negative stock price, which does not make sense. • The constant growth model can only be used if: • ks > g • g is expected to be constant forever

  21. Expected Rate of Return on a Constant Growth Stock: • Dividend yield • Expected growth rate, or capital gains yield

  22. Valuing Stocks with Nonconstant Growth: • Nonconstant Growth: The part of the life cycle of a firm in which its growth is either much faster or much slower than that of the economy as a whole.

  23. Valuing Stocks with Nonconstant Growth: • Compute the value of the dividends that experience nonconstant growth, and then find the PV of these dividends, • Find the price of the stock at the end of the nonconstant growth period, at which time it has become a constant growth stock, and discount this price back to the present, and • Add these two components to find the intrinsic value of the stock P0.

  24. Corporate Value Model: • Also called the free cash flow method. Suggests the value of the entire firm equals the present value of the firm’s free cash flows. • Remember, free cash flow is the firm’s after-tax operating income less the net capital investment • FCF = NOPAT – Net capital investment

  25. Firm Multiples Method: • Analysts often use the following multiples to value stocks. • P / E • P / CF • P / Sales

  26. Factors that affect stock price: • Required return (ks) could change • Changing inflation could cause kRF to change • Market risk premium or exposure to market risk (β) could change • Growth rate (g) could change • Due to economic (market) conditions • Due to firm conditions

  27. What is the Efficient Market Hypothesis (EMH)? • Securities are normally in equilibrium and are “fairly priced.” • Investors cannot “beat the market” except through good luck or better information. • Levels of market efficiency • Weak-form efficiency • Semistrong-form efficiency • Strong-form efficiency

  28. Preferred Stock: • Hybrid security • Like bonds, preferred stockholders receive a fixed dividend that must be paid before dividends are paid to common stockholders. • However, companies can omit preferred dividend payments without fear of pushing the firm into bankruptcy.

  29. Preferred Stock: • If preferred stock with an annual dividend of $5 sells for $50, what is the preferred stock’s expected return? Vp = D / kp $50 = $5 / kp kp = $5 / $50 = 0.10 = 10%

  30. The End of The Course.

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