Ch 8- Stocks Class Notes Flashcards
What are stocks
another way to finance a company that is not bonds (short term loans)
when you buy stocks you can get cash in 2 ways
- companies may pay dividends
- not very many companies pay dividends in canada, just 10% - sell ur stocks
What does listed mean?
You can buy and sell shares on an exchange such as the TSX without the company’s permission
listed: company has put shares into the market and given up control on who can own the shares
How to do stock questions- max willingness to pay
- Create a timeline, and see how much of a return you get in one year (dividend price) and year two (sale + dividend price)…
- Divide this by (1+rate of return) for year 1 and (1.##)^2 for the year 2
where 1+rate of return is the rate of % you want
this is just discounting cash flows
price of the stock is the present value of ALL expected future dividends + ONE sale (You can only sell this once)
When you are estimating dividends, what is the formula
P= C/r its the same formula as pertuity
the dividends will stay constant
Cash flow/interest rate
What is constant dividend growth, and the gordon grwoth model
the firm will increase the dividend by a constant percent per period
P0= D0(1+g)/R-g = D1/R-g
P0= Price stock is currently selling for
R= required return
g= growth rate
D0= Dividend year 0 (DIVIDEND THAT WAS JUST PAID)
D1- Dividend year 2 (DIVIDEND WE EXPECT TO GET IN THE UPCOMING YEAR, MAYBE @ YE) (stock PAYSSS a dividend) (IS EXPECTED TO PAY)
What is supernormal growth
What is zero growth
dividends are expected at reular intervals for ever, its like preferredd stock and valued as a perpetuity
the stocks return is ONLY frm its dividend
Po= D/r = dividend/ required return
formula to calculate the yield
THIS FORMULA CAN BE USED WHEN THERE IS A CONSTANT GROWTH RATE, IF THERE IS A CHANGING DIVIDEND GROWTH RATE THEN WE CANT USE THIS FORMULA
D1/P0= Dividend in the future year/ Price stock is currently selling for
when this formula can be used: r= Yield + growth
What is the sensitivity in the constant dividend growth rate formula?
If growth increases, then the stock price increases as well
1:1 ratio
How to use the gordon growth model for a year multiple years in the future
P4= D4(1+g)/r-g = D5/r-g
(we just expanded the initial formula) and adjusted the numbers
now we have to include the period increase
P4= (D4(1+g)^n )/r-g
Put the 1+growth rate ^ n number of periods in the future (4 for 4 years in the future)
in constant dividend growth…
the price grows at the same rate as the dividends
AND THIS MAKES SENSE!! AS THE PRICE OF THE STOCK GOES UP THEN DIVIDENDS SHOULD GO UP 1-1
What is nonconstant dividend growth?
when a firms dividends grow in a non-linear way
DO NOT FOLLOW THE GORDON GROWTH MODEL
How to do nonconstant dividend growth rate questions?
- draw a timeline, time 0 is the starting point
- to get year 1 dividend value, multiply year 0 dividend by year 1’s dividend rate
D1= og x 1.##A - Use the answer for D1 to replace the og and multiply by the Next years given rate
D2= D1 x 1.##B - Continue
D3= D2 x 1.##C - find the expected year price:
-think of yourself as standing at the year 2
- the next year in YOUR PERSPECTIVE is the NEW year 1
- Use the last calculated value you found (Df) in this formuls
Df/r-g
YOU CAN USE THE GORDON GROWTH MODEL AT THE VERY END HERE
- To find the present value of the expected future cash flows, discount all of the Ds you calculated by the growth rate
P0=( D1/1+g )+ D2 + P2 / (1+g)^2
-MAKE SURE YOU DO THIS PROPERLY!! FOR YEAR 1 divide it regularly, for YEAR 2 ^2