EQUITY VALUATION Flashcards
What can we use instead of P/E ratio if firm has negative earnings?
We can use the M/B ratio.
Market/Book ratio**
This ratio is used to denote how much equity investors are paying for each dollar in net assets.
The market to book ratio is calculated by dividing the current closing price of the stock by the most current quarter’s book value per share
Describe the characteristics of preferred shares
Preferred shares essentially pay a fixed amount just like bonds. Preferred shareholders have claims on the firm’s earnings and assets in the event of liquidation before common shareholders and they seldom have voting rights. Usually no payments can be made to common shareholders until preferred shareholders have been paid the dividends they are due in entirety. Preferred share prices increase when market rates decline, and vice-versa.
List the elements needed for the calculation of a share price using constant growth DDM
Elements needed are expected dividend, required rate of return, and the constant dividend growth rate.
Describe the constant growth DDM valuation method.
The constant growth DDM assumes a constant rate of growth in dividends, which is less than the required rate of return that will hold indefinitely. It discounts all the future expected dividend cash flows to the present to determine the current market share price. It is suitable for well-established companies that pay dividends that grow steadily.
Describe how to estimate PVGO and what it represents
PVGO mathematically equals P0 – (EPS1/kc). It assesses the market perception of the growth opportunities available to a firm. If the market perceives that a firm has no future growth opportunities, its PVGO will be zero and its market price reflects only its zero-growth component, which equals EPS1/kc. A positive PVGO increases the firm’s share price.
What is lagging and leading EPS?
Leading EPS requires an estimate of the growth rate of earnings.
Lagging EPS uses current earnings.
List three reasons why one firm may have a higher leading P/E ratio than a comparable firm.
All else being equal, the reasons why one firm may have a higher leading P/E ratio than a comparable firm are that it has:
1. A lower required rate of return.
2. A lower retention ratio, or a higher payout ratio.
3. A higher expected growth rate.
State the relationship that the required rate of return, the expected growth rate, and expected dividends have with the market share price, according to the constant growth DDM.
As indicated by equationP_0=(D_0 (1+g))/(k_c-g)=D_1/(k_c-g), market share price is positively related to the expected dividend D1 and expected growth rate g, but negatively related to the required rate of return kc.
What is the formula for the leading P/E ratio?
Leading P/E: Payout ratio/(k-g)
What is the expected capital gains yield?
The expected capital gains yield, is the growth rate.
This is because the expected capital gains yield is simply the amount the stock will increase from this year to the next year or otherwise the growth rate.
What does a constant P/E ratio imply ?
constant P/E ratio implies a constant growth over time—the growth could be zero, positive, or negative.
