S12: Stock Valuation Flashcards
Common Stock Valuation
Determined using PV calculations determined by cashflows security is entitled to receive
Dividend Discount Model (DDM)
Equates the intrinsic or “true” value of a stock to the PV of all future dividends paid to the stockholder
1. Dividends over a discrete period
2. Constant dividend growth
3. Multistage growth
Dividends Over a Discrete Period
Rewrites PV formula, V0=P0=(D1+P1)/(1+k)^t
Calculator Steps Dividends Over a Discrete Period
CFo=0
CO1=D1
CO2=D2
COn=Dn+Pn
I=k
Market Efficiency
Price = Value
Undervalued
Price<Value
Overvalued
Price>Value
Constant Dividend Growth
V0=P0=D1/(k-g)
Gordon Growth Model
Divides dividends in next period by required rate of return - growth rate (also used to value preferred stock and dividend aristocrats)
Multistage Growth
V0=P0=(D1/(1+k))+(D2/(1+k)^2)+((D3+D4/(k-g))/(1+k)^3)
Calculator Steps for Multistage Growth
CFo=0
Co1=D1
Co2=D2
Co3=D3+(D4/k-g)
I=k
Undervalued
Current trade price<CPTed value, you should buy
Overvalued
Current trade price > CPTed value, you should sell
Required Rate of Return (k)
Return investors require from an investment in order for them to commit to it given its level of risk, used to discount dividends -> k=(D1/P0)+g
Capital Gains Yield (g)
Expectation that a security’s price will grow beyond original purchase price
Dividends Yield (D1/P0)
$ from dividends
Capital Asset Pricing Model (CAPM)
A hallmark relationship in modern finance - used to calculate required or expected rate of return
CAPM Formula
E(R)=rf+B(E(Rm)-rf) (what gov’t pays + a little more for the risk)
rf
Risk free rate of return/yield of 90 day t-bill
B
Stock’s beta, a measure of risk
E(Rm)
Expected return of the stock market overall
Beta
Tells us how much a stock moves relative to the overall market -> B * movement of market = stock’s movement
PV of Free Cash Flows per Share
Other discounted cash flow model that can be used when firm doesn’t pay dividends
Valuation by Comparables
Method like average selling price per square foot of similar homes, used to find stock’s implied price
Implied Price
What price should be theoretically based on current market valuations
Comps
Comparable firms in the same industy
Price-Earnings (PE) Ratio
Price per share/earnings per share
Price-Book Ratio
Price per share/book value of equity per share
Price-Sales Ratio
Price per share/sales revenue per share
Enterprise Value of EBITDA
A measure of the company’s total value -> (Market cap + Debt - Cash)/EBITDA
Why do markets exist?
Different investors reach different conclusions on whether a stock is under or overvalued based on different inputs and assumptions
