Ch 6 - Stock markets and equity valuation Flashcards
What are primary markets?
Markets where securities are issued for the 1st time
What are secondary markets?
Markets where already issued financial instruments are traded
Common stock holders receive a _________ and liability is limited to the value of _______
Residual income, value of the ownership they hold
What are the 2 methods equity holders receive income in?
Dividends, income from selling shares
Value/ price of any financial instruments is equal to the __________
PV of all FCFs associated with it
Price of a share is equal to _____
The PV of the sum of all future dividends
What are the 3 main methods of valuing shares/ equity?
- dividend discount model
- constant growth model
- multi stage growth model
Describe the dividend discount model
This assumes dividend receivable on a stock is constant (it will not grow or decline in the future)
What is a disadvantage of the divided discount model?
It assumes dividend payment to be constant over time
In what 2 ways can a listed company utilise its profits?
- distribute profits as dividends to shareholders
2. retain profits and invest them in profitable opportunities, so that in the future higher dividends can be paid
What is pay out ratio?
Proportion of earnings paid out as dividends
What is plowback ratio?
Proportion of earnings retained by the firms
What is ROE?
Return on the funds invested again into the company
g= ______ x __________
retention rate x ROE
What is meant by the ‘sustainable growth rate’?
The rate at which the company can grow at without having to borrow money to fund investments
ROE being ______ than the cost of equity indicates that investments into the company’s operations are not profitable
Lower
What is meant by the cost of equity?
The total return demanded by equity holders for their investment
What is PVGO (Present value of growth opportunities)?
The difference between the value of a company which saves a portion of its earnings for future growth and a company which pays all earnings out as dividends
PVGO=?
Share price with growth - Share price without growth
PE ratio =
Price of a share/EPS
What does the PE ratio indicate?
How much investors are willing to pay for a share relative to earnings
Industries that have growth potential will have _____ PEs. Matured industries will have _____ PEs
Higher, lower
