Ch 8 Stock Valuation Flashcards by Unknown Unknown

Why is it hardder to value common stock than a bond?

3 reasons:
1. not even the promised cf are known in advance
2. the life of stock is forever (no maturity)
3. no way to observe the rate of return the market requires

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Formula for present value of a stock

P0 = (D1 + P1)/ (1+r)

D1= cash dividend
P1= price in one period
r= requred market rate

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What is the flaw with the Present value of stock formula?

you need to know the stock price in one period ahead

you can keep iterating forward and forward but this will only complicate things!

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so what IS the point of iterating out the present value of the stock formula?

the price of a stock today is = to the present value of all the future dividends!!!!

Po = D1/ (1+r) + D2/ (1+r)^2 …..

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what are 3 cases that we can use to determine the vlaue of a stock

dividend has zero growth rate
dividend grows at a constant rate
dividend grows at a constant rate after some length of time

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ZERO GROWTH RATE STOCK

all dividends are the same, so this is a constant
this is an ordinary perpetuity

Po = D/r

D: Dividend every period
r: the required return

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CONSTANT GROWTH STOCK

dividend growth model

-when dividend is growing at a steady rate (g)
- a stock with dividends growing lik ethis is a GROWING PERPETUTITY

Po = Do x (1+g) / r-g = D/r-g

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dividend aristocrats

companies like banks that have a policy of consitently increasing dividends every year!!! THEY MUST DO IT

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how to use the dividend growth model to calculate the stock price in a future year?

calgaulate the future value of the dividend by using:
Dt=PV(1+g)^t
Plug this into dividend growth model

Pt= Dt x (1+g) / r-g

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Why does r> g always in the dividend growth rate model

bc if r=g or r<g then stock price is infinitely large (dividends get bigger and bigger so this is nonsense)

NOTE: g>r for some period of time, but not indefintiely

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TRICKY PORTION OF DIVIDEND GROWTH RATE MODEL

IF YOU ARE GIVEN THE AMOUNT FOR THE NEXTTTTTT DIVIDEND!!!

do not use Do x (1+g)/r-g

USE D1/r-g!!!

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Non constant growth

-sometimes there are supernormal growth rates over finite length of time

-we assume that the
dividends start growing at a constant rate sometime in the future

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How to deal with non constant growth rates?

SCENARIO 1: WHEN DIVIDENDS ARE ZERO FOR THE FIRST SEVERAL YEARS

you must find out what the stock will be worth once dividends are paid

use P0 = D1/ r-g
P0=FV

calculate pv of the futureprice to get todays price

PV= FV/1+r ^t

NOTE: t is the last year where there are 0 dividends

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How to deal with non constant growth rates?

SCENARIO 2: WHEN DIVIDENDS ARE NONZERO FOR THE FIRST SEVERAL YEARS

g= long run growth rate
G= short run growth rate

0) make a table,
year | expected div = div
0 total div (1+G) div0
1 div0(1+G) div1
2 div1(1+G) div2
3 div2(1+G) div3

1) start with calculatung the pv of all future dividends (use the dividend furthest out from today as D, so if 3 years= D3)

P3= D3 x (1+g)/ r-g

2) discount all cash dividends to present, add them, and add discount fof the P0 you just calculated as well

P0 = Div1/(1+r) + Div2/(1+r)^2 … + P3/(1+r)^t

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2 criticisms of dividend growth model

First, in the late 1990s, the level of the market, and
especially tech stocks, was far higher than the present value of expected dividends. Second, market
prices are far more volatile than the present value of dividends

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formula for the required return (r)

r= D1/P0 + g

D1/P0 is called dividend yield

g is the rate at which investmenet grows= CAPITAL GAINS YIELD

r= dividend yield + capital gains yield

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how do value stock of companies that dont pay dividends?

USE benchmark PE ratio * EPS to come up with a price

Price at time t = Pt
Pt= Benchmark PE x EPSt

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what does benchmark PE ratio come from

similar companies, historical data,

note that the ratio can differ depending on industries

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What if a company does not pay dividends and is very new and not yet profitable? (net earnings are negative)

how do we price it?

use price-sales ratio

Pt= benchmark price sales x sales per share

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what is common stock

stock that has no special preference in dividends or in bankruptcy

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structure of a corporation

shareholders elect directors

directors hire management

directors are hired yearly at an annual meeting

one share one vote not one shareholder one vote

not everyones vote matters equally-> hwo has more at stake has more say

proxy contest

a fight for shareholder votes between parties attmepting to control the corporation

say on pay policy

gives shareholders a voice in determining exec pay packagies

other rughts shareholders have

right to share proportionally in dividends paid riht to share proportionally in residual value of assets right to vote on matters of importance (merger etc)

PREEMPTIVE RIGHT

SOMETIEMSSSS sometimes have the right to share proportionally in any new stock sold

Dividends- important characteristics

1. unless dividends are declared there is no obligation to pay 2. they are non tax deductible cuz not a business expense (paid from after tax profits) 3. dividends recieved by individual SH are sort of sheletered by a div tax credit (to prevent double taxation of dividends)

classes of stock

voting and non voting both must recieve the same amount of dividends (sometimes non voting gets more!)

why are there two classes of stock?

manging the contorl of the firm non voting stock= raise capital while still maintaining control

DO YOU NED 51% OF THE SHARES TO HAVE MAJORTIY? Because it is necessary to own only 51% of the voting stock to control a company, non-voting shareholders could be left out in the cold in the event of a takeover bid for the company. To protect the non-voting shareholders, most companies have a “coattail” provision giving non-voting shareholders either the right to vote or to convert their shares into voting shares that can be tendered to the takeover bid. In the Canadian Tire case, all Class A shareholders become entitled to vote and the coattail provision is triggered if a bid is made for “all or substantially all” of the voting shares

NOOOOOOOOOOO only half + 1

what is preferred stock

has preference over common stock!!! if bankruptcy they get paid first have no voting priveleges

stated value

prefered shares have a liquidating value=stated value

can dividends o fpreferred stock be either cumulative or non cumulative?

yes either

if a dividend on preferred stock is cumulative and not paid in a year, what happens

dividends in arrears!! it is carried forward as an arrear age!!! THese are not debt to the firms, but common SH cant recive dividends, and to amend not recieiving dividends preferred shareholders get voting rights

why do firms issue preffered stock and not debt

-unpaid div in arrears is not debt! so no bankruptcy -preffered sh can not vote so still retain control on the demand side, mostly corps own preffer stocks, and corporate income from preffered stock is tax exempt (EVEN THO THE ISSUER DOESNT ENJOY A TAX BEENFIT)

If the volume of stock is 80 what does that mean

80 stocks exchanged hands

cash cow

when a company issues all of its earnings per share as dividiends EPS= DIv value of a share of stock in a cash cow: EPS/r = cash cow price

why are not all companies cash cows

paying out all earnings as dividends may not be the optimal one. Many firms have growth opportunities; that is, opportunities to invest in profitable projects. Because these projects can represent a significant fraction of the firm’s value, it would be foolish to forgo them to pay out all earnings as dividends

what is the stock price after firm commits to new projects (growth opportunities)

EPS/r + NPVGO EPS/r: current value of the firm without project NPVGO: NPV per share of growth opportunity: additional value if firm retains earnings to fnd new projects

WHAT IS THE PREFFERED STOCK LIKE IN A SPECIAL CASE??

THE CONSTANT DIVIDEND

as required return increases

stock price decreases

as growth rates icrease

stock prices increase

EV/EBITDA multiple

EV: Ent Value= Mkt val of eq + mkt val of debt - cash this is called acquirers multiple (its the cost to buy the whole company) [buy all the equity, assume all debt, and use cash to pay for it] EBITDA: cash generated by firm to all stakeholders (+govt and creditors) BOTH EV AND EBITDA INCLUDE DEBT AND EQUITY

Dividends and Taxes − Dividend payments are not considered a business expense and are not tax deductible. − Dividends received by individual shareholders are partially sheltered by the dividend tax credit. − Dividends received by corporate shareholders are not taxed. − This prevents double taxation of dividends

Stock market quotations are published in the newspapers and are also available on-line (usually with a 15-minute delays during trading hours) * In Canada, large cap stocks trade on the TSX * Quotes and corporate information on stocks that trade on the TSX can be found at the exchange’s website

How to use EV/EBITDA multiple?

1) for the alternative with all the EV and Ebitda elements, DIVIDE EV/EBITDA 2) the qquotient you get is the multiple 3) For the next alt multiply multiple by EV/EBITDA, and solve for what the price per share should be

2 ASSUMPRIONS OF DIV GRPWTH MODEL

he dividend growth model presented in the text is only valid (i) if dividends are expected to occur forever, that is, the stock provides dividends in perpetuity, and (ii) if a constant growth rate of dividends occurs forever.

dividends are fixed on preffered stock!! can grow on coommon

this is whu common stock might be priced higher

If the dividend grows at a steady rate, so does the stock price. In other words, the dividend growth rate and the capital gains yield are the sam

CAPITLA GAINS YIELD= DIVIDEND GROWTH RATE

As the required return increases, the stock price decreases. This is a function of the time value of money: A higher discount rate decreases the present value of cash flows