Chapter 13
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Chapter 13. Equity Valuation. 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. Intrinsic Value and Market Price. Intrinsic Value Self assigned Value

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Chapter 13

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Chapter 13

Chapter13

Equity Valuation


Fundamental stock analysis models of equity valuation

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


Intrinsic value and market price

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


Dividend discount models general model

Dividend Discount Models:General Model

  • V0 = Value of Stock

  • Dt = Dividend

  • k = required return


No growth model

No Growth Model

  • Stocks that have earnings and dividends that are expected to remain constant

  • Preferred Stock


No growth model example

No Growth Model: Example

E1 = D1 = $5.00

k = .15

V0 = $5.00 / .15 = $33.33


Constant growth model

Constant Growth Model

  • g = constant perpetual growth rate


Constant growth model example

Constant Growth Model: Example

E1 = $5.00b = 40% k = 15%

(1-b) = 60%D1 = $3.00 g = 8%

V0 = 3.00 / (.15 - .08) = $42.86


Estimating dividend growth rates

Estimating Dividend Growth Rates

  • g = growth rate in dividends

  • ROE = Return on Equity for the firm

  • b = plowback or retention percentage rate

    • (1- dividend payout percentage rate)


Shifting growth rate model

Shifting Growth Rate Model

  • g1 = first growth rate

  • g2 = second growth rate

  • T = number of periods of growth at g1


Shifting growth rate model example

Shifting Growth Rate Model: Example

D0 = $2.00 g1 = 20% g2 = 5%

k = 15% T = 3 D1 = 2.40

D2 = 2.88 D3 = 3.46 D4 = 3.63

V0 = D1/(1.15) + D2/(1.15)2 + D3/(1.15)3 +

D4 / (.15 - .05) ( (1.15)3

V0 = 2.09 + 2.18 + 2.27 + 23.86 = $30.40


Specified holding period model

Specified Holding Period Model

  • PN = the expected sales price for the stock at time N

  • N = the specified number of years the stock is expected to be held


Partitioning value growth and no growth components

Partitioning Value: Growth and No Growth Components

  • PVGO = Present Value of Growth Opportunities

  • E1 = Earnings Per Share for period 1


Partitioning value example

Partitioning Value: Example

  • ROE = 20% d = 60% b = 40%

  • E1 = $5.00 D1 = $3.00 k = 15%

  • g = .20 x .40 = .08 or 8%


Chapter 13

Partitioning Value: Example

Vo = value with growth

NGVo = no growth component value

PVGO = Present Value of Growth Opportunities


Price earnings ratios

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


P e ratio no expected growth

P/E Ratio: No expected growth

  • E1 - expected earnings for next year

    • E1 is equal to D1 under no growth

  • k - required rate of return


P e ratio with constant growth

P/E Ratio with Constant Growth

  • b = retention ration

  • ROE = Return on Equity


Numerical example no growth

Numerical Example: No Growth

E0 = $2.50 g = 0 k = 12.5%

P0 = D/k = $2.50/.125 = $20.00

PE = 1/k = 1/.125 = 8


Numerical example with growth

Numerical Example with Growth

b = 60% ROE = 15% (1-b) = 40%

E1 = $2.50 (1 + (.6)(.15)) = $2.73

D1 = $2.73 (1-.6) = $1.09

k = 12.5% g = 9%

P0 = 1.09/(.125-.09) = $31.14

PE = 31.14/2.73 = 11.4

PE = (1 - .60) / (.125 - .09) = 11.4


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