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NCBA&E
Multiple/Variable Growth
Components of Required Return Features of Stocks Stock Markets
Equities
Preferred Stock Common Stock
Stocks
It is an equity ownership in a corporation, initially issued to raise capital Points to keep in mind (vs Bonds)
Stocks
How do we come up with the Price of a Stock? PV of all future expected C/Fs? Assumptions will be needed!
Stocks Valuation
Assumptions will be needed!
Assume a dividend the stock will pay. Assume a selling price at the end of 1 year. Come up with a required rate of return.
Stocks Valuation
Example: For 1 year
Stock selling price is $70 (P1) Stock dividend will be $10 (D1) U need a 25% return (R) PV will be 80/(1.25) = $64 (Po) (u should pay today)
Stocks Valuation
Example: For 1 year
P1 @ t1, would be found the same way by assuming the year 2 price & dividend: P1 = (D2+P2) / (1+R) Here then P1 really equals the P1 we used at Po. Thus we can substitute:
Stocks Valuation
Example: For 1 year
substituting P1 in Po equation:
Stocks Valuation
Formula: Po = E Dn / (1+R)^n PV of all future dividends
Stocks Valuation
The problem of NO dividends.
This formula assumes the company will pay something at some point in its life to its shareholders.
A Corp where money goes in but nothing comes out doesnt exist. Or shouldnt exist!
Stocks Valuation
Stocks Valuation
Example zero-growth
If this policy is forever, Whats the stock price if the required return is 20%?
Stocks Valuation
Example zero-growth
If this policy is forever, Whats the stock price if the required return is 20%?
Po = 10 / 0.2 = Rs 50 per share
Stocks Valuation
Special Cases. of dividends Constant Growth Model:
Suppose the dividend grows at a constant rate g.
If dividend just paid is Do, then the next D1 is:
D1 = Do x (1+g)
& for 2 periods is: D2 = Do x (1+g)^2
D2 = (Do x (1+g)) x (1+g)
(FV formula)
Stocks Valuation
Growing Perpetuity:
An asset where the C/Fs grow at a constant rate forever.
Stocks Valuation
Dividend Growth Model:
Determines the Stock Price with constant growth dividends.
Po = Do x (1+g) / R-g OR
D1 / R - g
(g<R)
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
D1 / R - g
(g<R)
Stocks Valuation
Note: You can use this to find the stock price at any point in time!
Just find the D for that year,
grow it at (1+g)
& then divide by R-g
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
D6 / R - g
(g<R)
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
D6 / R - g
(g<R)
Stocks Valuation
Example:
Suppose Company Ts next dividend will be $4. Required return is 16%. Dividend increases by 6% every year.
& in 4 years?
Stocks Valuation
Example:
Suppose next dividend will be $4. Required return is 16%. Dividend increases by 6% every year. D1 = 4 , R=16%, g=6%. (since D1 is given, dont need to grow by g)
Po = D1 / R - g
Whats the price per share in 4 yrs?
(g<R)
Stocks Valuation
Notice here:
So, Stock price grows at the same constant rate as the Dividend! P4 is simply D5/(R-g)
R = D1/ Po + g
If a stock is selling for $20 per share. Next dividend will be $1 per share. Dividend will grow by 10% per year forever.
What is the return on this stock?
R = D1/ Po + g If a stock is selling for $20 per share. Next dividend will be $1 per share. Dividend will grow by 10% per year forever. What is the return on this stock?
Stocks Valuation
Multiple Growth Model
Company grows at a certain high rate first, then slows down to grow at a constant sustainable rate.
illustrate concept
Stocks Valuation
Multiple Growth Model
Company grows at a certain high rate first, then slows down to grow at a constant sustainable rate. Value = PV of dividends + PV of terminal price = E Do(1+g)^t / (1+k) + Dn(1+g)/(k-g).1/1+k^n illustrate concept
Stocks Valuation
Intrinsic Value & Market Price
If
Stocks Valuation
Multiple growth
Example:
MCB is expanding and is expected to grow at a rate of 20% per year for the next three years. Current dividend is Rs. 2 per share. After this rapid growth, the company is likely to slow down to a normal growth of 7% for the foreseeable future. Required return on this stock is 22%. D1 = 2*(1.20) = 2.40 , R=22%, G1= 20%, g=7%.
P/E = Payback period! P/E = 15, EPS= $3, Px=45 So P/E of 15= 15 years payback! Also: 1/15 = 6.66% yield indicating low pay-off for investors!
Making Valuations through comparisons P/BV = Price to Book Value (S.Equity) ratio
so if comparable stocks are trading at x10. & BV for a stock is equal to: $5 What should be the stock price?
50
Financial Markets
Short-term debt Long-term debt Equity shares
D. Government
DIRECT INVESTING
Non-Marketable
Equities
Preferred Stock Common Stock
Common Stock:
Voting Rights:
After payment of all obligations to fixed-income claims, provides residual claim. b/w Bonds & common stocks. However, dividends may be deferred.
Preferred Stock: Hybrid security: Pays dividends known in advance & falls Common Stock:
Represents ownership interest of corporations or Equity of stock holders (also called Equity securities)
Example: 100 shares of common stock represents 100/n% ownership interest in the corp (n=outstanding shares).
Limited Liability:
Market Value (Cap): Dividends:
Dividend Yield:
Payout Ratio: Retention Ratio:
Book Value: The accounting value of the equity as shown on the Balance Sheet.
Sum of Stock Outstanding, Capital in excess of Par & Retained Earnings.
Creditors
Market Value:
Dividends: Cash Payments declared & paid to stockholders Dividend Yield: 12 month dividend / current stock price Payout Ratio: Dividends / Earnings (indicates % of a firms earnings paid out) Retention Ratio: 1 Payout Ratio (% of firms earnings retained)
Stock Example
Coca-Colas 2002 EPS = $1.23. Paid annual dividend DPS of $0.8. If price of KO is $45, calculate the following.
DY? Payout ratio?
If the company reported $11.8 Billion in Stockholder Equity & the outstanding shares are 2.478 Billion, whats the BVS?
Stock Example
Coca-Colas 2002 EPS = $1.23. Paid annual dividend DPS of $0.8. If price of KO is $45, calculate the following.
Dividend Yield: 0.8/45 = 1.8% Payout Ratio: 0.8/1.23 = 65%
If the company reported $11.8 Billion in Stockholder Equity & the outstanding shares are 2.478 Billion, whats the BVS?
BVS = 11.8 / 2.478 = $4.76
Financial Markets?
US Securities Markets for Equities
Dow Jones Industrial Average
Nasdaq
Financial Markets?
US Securities Markets for Equities
Dow Jones Industrial Average
30 Blue chip stocks stock price weighted average
Nasdaq
100 Large cap companies
The Dow Jones Industrial Average consists of the following 30 companies: 3M Co. (NYSE: MMM) (conglomerates, "manufacturing") ALCOA Inc. (NYSE: AA) (aluminium) Altria Group, Inc. (NYSE: MO) (tobacco, foods) American International Group, Inc. (NYSE: AIG) (property & casualty insurance) American Express Co. (NYSE: AXP) (credit services) AT&T Inc. (NYSE: T) (telecoms) Boeing Co., The (NYSE: BA) (aerospace/defense) Caterpillar, Inc. (NYSE: CAT) (farm & construction equipment) Citigroup, Inc. (NYSE: C) (money center banks) Coca-Cola Co. (NYSE: KO) (beverages) E.I. du Pont de Nemours & Co. (NYSE: DD) (chemicals) Exxon Mobil Corp. (NYSE: XOM) (major integrated oil & gas) General Electric Co. (NYSE: GE) (conglomerates, media) General Motors Corporation (NYSE: GM) (auto manufacturers) Hewlett-Packard Co. (NYSE: HPQ) (diversified computer systems) Home Depot, Inc. (NYSE: HD) (home improvement stores)
Honeywell International, Inc. (NYSE: HON) (conglomerates) Intel Corp. (NYSE: INTC) (semiconductors)
Types of Orders
Market Order
Limit Order Stock Order
Types of Orders
Market Order
Limit Order
Best price on the floor ENSURES EXECUTION NOT PX specified or better price ENSURES PX NOT EXECUTION
Stop Order
Automatic execution at specified price BUY STOP PROTECTS PROFITS SELL STOPS PROTECT LOSSES
Short Sales
Being Long
Being Short Short Sale
Short Sales
Being Long
normal position of buying stock
Being Short
having sold stock not owned
Short Sale
selling stock not owned but borrowed