DDM Equity valuation

Question 1

How does fundamental analysis model a company’s value?

Answer 1

Fundamental analysis models a company’s value by assessing its current and future profitability

Question 2

What is the purpose of fundamental analysis?

Answer 2

The purpose of fundamental analysis is to identify mispriced stocks relative to a “true” value that we derive from financial data

Question 3

What are good ratios for valuing startups and why?

Answer 3

Ratios such as price/sales ratios are good for valuing startups because there is little to no historic revenue/market data, and have yet to generate positive earnings

Question 4

What’s the difference between book and market value?

Answer 4

Book values are based on historical cost of the stock, whereas market value is based on the general consensus/aggregate opinion of investors in the market.

Question 5

What is the floor value?

Answer 5

The floor value is the minimum/liquidation value per share

Question 6

What is the formula for Holding period return?

Answer 6

The formula for holding period return is:

Dividend + P1-P0 / p0

Question 7

If the stock is priced correctly, what is k equal too?

Answer 7

K is the market capitalisation rate, and if the stock is priced correctly then k should equal expected return

Question 8

What is the difference between market and intrinsic value?

Answer 8

The difference between market and intrinsic value is that intrinsic value is a more factual “true” value of a stock according to the model:

Question 9

What is the trading signal for IV > MV, IV < MV, IV = MV?

Answer 9

IV > MV, buy the stock
IV = MV, hold the stock
MV > IV, sell the stock.

Question 10

What does the DDM say about the stock price?

Answer 10

The DDM says that the stock price should be equal to the present value of all the expected future dividends into perpetuity

Question 11

What 3 things does the constant-growth rate DDM imply about a stock’s value?

Answer 11

• The larger its expected dividend per share
• The lower the market capitalisation rate
• The higher the expected growth rate of dividends

Question 12

What is market capitalisation rate?

Answer 12

The market capitalisation rate is the rate calculated by dividing an asset net income by the current market value

Question 13

In g = ROE x b, what are the three coefficients?

Answer 13

In g = ROE x b:
G = growth rate on dividends
ROE = Return on equity for the firm
B = plowback or retention percentage rate

Question 14

What is the value of a firm made up of?

Answer 14

The value of a firm is made up of it’s value of current assets, plus the value of it’s future/expected growth

Question 15

What is PVGO?

Answer 15

PVGO is present value of growth opportunities

Question 16

What happens when PVGO = 0?

Answer 16

When PVGO = 0, the stock is valued like a nongrowing perpetuity

Question 17

P/E rises dramatically with …

Answer 17

P/E rises dramatically with PVGO

Question 18

What does a high P/E indicate?

Answer 18

A high P/E ratio indicates a high chance of future growth of the company
A high P/E ratio indicates the firm has ample growth opportunity.

Question 19

What happens to P/E as ROE and plowback increases?

Answer 19

P/E increases as ROE and plowback increases, as long as ROE > k.

Question 20

What is the wall street P/E rule of thumb and P/E vs growth rate rule of thumb?

Answer 20

The wall street consensus is that the growth rate is roughly equal to the P/E ratio.