IP - Chapter 11 - Equity Securities Valuation* Flashcards
Price an investor believes a stock is worth based on fundamental analysis
Intrinsic Value
Two broad types of common stock valuation models for going concerns are?
1) Absolute Value
2) Relative Value
A business that is expected to continue operations indefinitely
Going concern
What is ‘absolute value’ common stock valuation?
Identifies a stock by its intrinsic value (based on PV of future cashflows)
What is ‘relative value’ common stock valuation?
Compares the firms stock price to other similar companies
What is an example of absolute value common stock valuation?
Dividend Discount Model
What is an example of relative value common stock valuation?
PE Ratio
An absolute valuation of common stock technique that attempts to point estimate of future cash flows discounted at an appropriate discount rate today?
Present Value Model
Limited operational business life (ie. typewriter company)
Not a going concern
How are companies that are not a going concern valued?
FMV of companies assets minus FMV of companies liabilities
What is the Basic Present Value Model formula that calculates the value of a security today?
CF1 / ((1 + Discount Rate) ^ Year)
What model allows for growth rates to change over time?
Two Stage Dividend Growth Model
Companies in the S&P 500 that have increased their dividends consistently over the last 25 years.
Dividend Aristocrats
V = D1 / (r - g)
Constant growth dividend model (ON CFP FORMULAS SHEET)*
V = Value of Stock D1 = Dividend per share (also computed as D1(1+g)) r = required return of investor g = dividend growth rate
r = (D1/P) +g
Constant Growth Dividend Model when given a price
In theory, a firms operating cashflow can only grow if:
1) Operating Cashflows increase
2) External Financing
Measure of cashflow to be paid to shareholders
FCFE (Free Cashflow to Equity)
Means identical assets should sell for identical prices
Law of 1 Price
What are 4 common relative valuation methods?
PE Ratio, Price to Book, Price to Sales, PEG Ratio
What are ratios like PE and P to B also referred to as?
Multiples
Amount of money investors are willing to pay for a single dollar worth of earnings
PE Ratio
What is another formula for PE Ratio?
(D1 / E) / (r - g)
This ratio is a measure of PE Ratio per unit of EPS Growth
PEG Ratio:
PE Ratio / EPS Growth
(Total Market Value Price X Shares Outstanding) / (Sales)
Price to Sales Ratio
Undervalued firms typically have low ___________ ratios?
Price to Book
This model estimates cash flows the security is likely to pay and them discounts them at the appropriate interest rate to find value?
Basic Present Value Model
This model computes value as the present value of an infinite growing dividend stream?
Dividend Discount Model
This model helps to estimate a firms intrinsic value per share?
Constant Growth Dividend Model
How can a firms dividend growth rate be estimated ? (2 ways)
1) Retention Ratio
2) Firms Return on Equity
How is preferred stock valued?
Using the zero growth rate assumption in the dividend discount model
(ie. V = D1(1+g) / (r - g)… setting g = 0 makes V = D1/r)
This model assumes that a firms dividends grow at DRAMATICALLY/EXTREMELY different rates during a high growth period that is followed by an infinite normal growth period.
Two stage dividend discount model
The expected future selling price in the two stage dividend discount model?
Terminal Price
Dividend discount model in which dividends change GRADUALLY from a high growth rate to a low normal growth over a period of years.
H Model
For firms that either do not pay dividends or for firms that pay dividends that are substantially different than its earnings, __________ can be used as an input variable in a present value model to estimate intrinsic value.
Free Cash Flow
Cash available to common share holders after the firms bond-holders and preferred share holders have been paid?
Free Cash Flow to Equity
The most commonly used relative valuation measure?
Price to Earnings Ratio
Lower ratios of this imply undervaluation?
PEG Ratio
How do you calculate PEG Ratio?
PE Ratio/EPS Growth Rate
Ratio of a firms stock price to its revenues per share
Price to sales ratio
Ratio of a firms stock price to its cashflow per share
Price to cash flow ratio
PE Ratio based on expected 12 months of earnings
Leading PE Ratio
PE Ratio based on trailing 12 months of earnings or the most recent four quarters.
Trailing PE Ratio
These values can be estimated using the present value approach even though they have different types of cashflows?
Both Stock Values and Bond Values
If the market price of a firms stock is less than its intrinsic value the stock is most likely to be _______________ .
Undervalued
This approach is appropriate for natural resource firms.
FMV approach
When utilizing the constant dividend growth model you must first solve for what?
Growth rate (ie. Interest rate) using financial calculator
BE SURE TO KNOW CFP GIVEN FORMULA SHEET!
How to calculate required rate of return if it is not given in a problem?
Use CAPM Formula to solve
–> RFR + Beta(Market Return - RFR)
