Equities: Concepts and basic tools Flashcards
Deciding to invest in a mis-priced security x5 =
- bigger mispricing = more likely to take a position
- more confident about a security being mispriced = more likely to take a position
- more confident about the accuracy of the inputs into the model = more likely to take a position
- investors must consider why a security might be mispriced; if less analysts follow it, the investor may be more willing to take a position
- MUST BELIEVE THAT THE MARKET WILL ACTUALLY ADJUST TO THE ESTIMATED INTRINSIC VALUE
Discounted cash flow models =
aka present value models
stock’s value is estimated as
a) present value of cash distributed to shareholders (DIVIDEND DISCOUNT MODEL)
b) present value of cash available to shareholders after the firm meets capex and working capital expenditures (FREE CASH FLOW TO EQUITY MODEL)
Multiplier models =
a) ratio of stock price to some fundamental measure: ie P/E ratio
b) ratio of ENTERPRISE VALUE to either EBITDA or REVENUE
Asset based models =
intrinsic value of common stock is estimated as total asset value minus liabilities and preferred stock
analysts will typically adjust the book value of the firm’s assets and liabilities to fair value when estimating the market value of its equity with an asset-based model
ASSET BASED VALUATION IS BEST FOR FIRMS WITH MAINLY TANGIBLE, SHORT TERM ASSETS WITH READY MARKET VALUES or WHEN A FIRM IS BEING LIQUIDATED
Dividend Discount Model =
For a one year holding period the value of the stock today is the PV of
a) dividends received this year
b) price at the end of the year (this is the terminal value)
note that we discount by the REQUIRED RATE OF RETURN ON COMMON EQUITY
DDM: Multiple year holding period =
same as regular discount dividend model - just discount each dividend by the appropriate discount factor (to the power of 2 for the 2nd year dividend)
do note that the terminal value is discounted at the same rate/discount factor as the last dividend
DDM: w infinite holding period =
as corporation is assumed to have an infinite life
PV of all expected future dividends is calculated and there is no explicit terminal value
WHEN THE GROWTH RATE OF DIVIDENDS IN THE FUTURE IS CONSTANT we will be able to calculate a terminal value
FCFE model =
reflects the CAPACITY of the firm to pay dividends - good for firms not currently paying dividends.
= CFO - FCInv [fixed capital investment] + net borrowing
or the more complicated version…
= net income + depr - increase in working capital - FCInv - debt principal repayments + new debt issues
FCFE in terms of DDM formula:
Estimating RRR =
can use the CAPM model
note that analysts may add a risk premium to the firm’s current bond yield to estimate RRR (if there is publicly traded debt outstanding)
Intrinsic value of pref stock (infinite life) =
same as a a perpetuity..
Intrinsic value of pref stock (semi annual div, finite life) =
essentially the same as the dividend discount model…
with the ending price being the par value
Gordon growth model =
MOST APPROPRIATE FOR MATURE/STABLE, NON CYCLICAL, DIVIDEND PAYING COMPANIES
assumes
- dividends are the appropriate measure of shareholder wealth
- the annual growth rate of dividends is constant
- required return on stock doesn’t change
- required return is greater than the dividend growth rate (otherwise the math won’t work)
essentially same as the DDM, but the numerator/dividend grows by the growth rate period by period… simplifies to the below
Estimating stock value due to dividend growth =
set g=0 and then subtract this value from the value resulting from a positive growth rate
Estimating ‘g’, dividend growth rate =
- use historical growth of dividends for the firm
- use median industry dividend growth rate
- estimate SUSTAINABLE GROWTH RATE
SUSTAINABLE GROWTH RATE = ROE X (1-DIVIDEND PAYOUT RATIO)
Multistage dividend growth model =
calculate the PV for dividends paid out before the firm reaches a constant dividend growth rate, then use the Gordon formula to calculate the stock value at the end of the initial ‘high growth period’ -
ADD THE PVs OF THE HIGH GROWTH DIVIDEND PERIOD AND THE PV OF THE TERMINAL VALUE ONCE CONSTANT GROWTH IS REACHED
note that if the first constant growth dividend is at the end of period 4, we calculate the V (value) using this figure, which gives us the V at period 3 - we use this to calculate PV (discounting by 3 periods, along with the 3rd dividend, and leaving out the 4th dividend entirely - this is included in the period 3 terminal value)
LOOKS COMPLICATED BUT ISN’T HAHAHA FUCK.
