Lesson 2: Equity Flashcards
How do you value preferred shares?
Perpetuity Formula
How do you value common shares?
Dividend discount model (one and two stage)
What are the stock-like features of preferred shares?
No maturity date, pays a dividend
What are the bond-like features of preferred shares?
Fixed dividend, essentially a perpetual bond
Do preferred shares have voting rights?
No
In bankrupcty when are preferred stock paid in relation to common stock and debt?
Debt, then preferred stock, then common stock
What is the simplified price formula for preferred shares?
Price = Div / rps
rps = requried rate of return for preferred shares
What is a Seasoned Equity Offering?
The sale of additional shares after the IPO
What are the three estimates that we need to make in a single-stage DDM?
- Div1 (first future dividend an equity investor is expected to receive
- re (required return by equity holders)
- g (constant rate of growth in dividends in perpetuity
How do you estimate “g”?
Using the firm’s sustainable growth rate as a proxy
What is a sustainable growth rate?
A company’s max rate of growth that can be achieved using internally generated funds
What does the sustainable growth rate depend on?
- Return on Equity
- Retention Ratio (1-Payout Ratio)
What is the ROE formula?
Net Income / Book Value of Equity
What does “g” represent?
The expected growth rate in dividends until forever
What is the Payout Ratio?
Payout Ratio = Dividend per Share / Earnings per Share
When your goal is to proxy “g” in DDM, do you want to use ROE for a specific year?
Do not use ROE for a specific year, but want to think more generally what is the ROE that the company can generate long-term
What is a reasonable assumption when deciding on a ROE?
The company is going to generate internally a ROE that is similar to what investors providing equity capital are expecting
Therefore, if using gSust.growth as proxy for “g” assume ROE ~ re
What DDM do we use when projected growth is not constant?
Two stage model
What is a synonym for earnings per share?
Net Income per Share
What is a synonym for Net Income per Share?
Earnings per Share
How do you present value a price by half a year?
Div0 (6 months ago) is given, multiplied by g to get Div1 (6 months in future)
Perpetuity formula Div1/(re-g) will give present value at year0 (6 months ago)
PV1 / (1+re)1 present values PV1 (1 year back) to year0 (6 months ago), therefore
PV0 / (1+re)0.5 present values PV1 (0.5 year back) to year-0.5, therefore
to get to year0.5, PV0 * (1+re)0.5 we multiply to present value PV0 (0.5 years forward)
this leaves us PV0.5 (which is now)
