1、 STOCK VALUATIONCHAPTER 8Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Explain how stock prices depend on future dividends and dividend growth Show how to value stocks using multiples Lay out the di
2、fferent ways corporate directors are elected to office Define how the stock markets workKey Concepts and SkillsCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Common Stock Valuation Some Features of C
3、ommon and Preferred Stocks The Stock MarketsChapter OutlineCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.If you buy a share of stock,you can receive cash in two ways:The company pays dividends.You s
4、ell your shares,either to another investor in the market or back to the company.As with bonds,the price of the stock is the present value of these expected cash flows.Cash Flows for StockholdersCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior
5、 written consent of McGraw-Hill Education.Suppose you are thinking of purchasing the stock of Moore Oil,Inc.You expect it to pay a$2 dividend in one year,and you believe that you can sell the stock for$14 at that time.If you require a return of 20%on investments of this risk,what is the maximum you
6、would be willing to pay?Compute the PV of the expected cash flows.Price=(14+2)/(1.2)=$13.33 Or FV=16;I/Y=20;N=1;CPT PV=-13.33One-Period ExampleCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Now,what
7、if you decide to hold the stock for two years?In addition to the dividend in one year,you expect a dividend of$2.10 in two years and a stock price of$14.70 at the end of year 2.Now how much would you be willing to pay?PV=2/(1.2)+(2.10+14.70)/(1.2)2=13.33Two-Period ExampleCopyright 2019 McGraw-Hill E
8、ducation.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Finally,what if you decide to hold the stock for three years?In addition to the dividends at the end of years 1 and 2,you expect to receive a dividend of$2.205 at the end of year 3
9、 and the stock price is expected to be$15.435.Now how much would you be willing to pay?PV=2/1.2+2.10/(1.2)2+(2.205+15.435)/(1.2)3=13.33Three-Period ExampleCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Educati
10、on.You could continue to push back the year in which you will sell the stock.You would find that the price of the stock is really just the present value of all expected future dividends.So,how can we estimate all future dividend payments?Developing The ModelCopyright 2019 McGraw-Hill Education.All r
11、ights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Constant dividend(i.e.,zero growth)The firm will pay a constant dividend forever.This is like preferred stock.The price is computed using the perpetuity formula.Constant dividend growth The firm
12、 will increase the dividend by a constant percent every period.The price is computed using the growing perpetuity model.Supernormal growth Dividend growth is not consistent initially,but settles down to constant growth eventually.The price is computed using a multistage model.Estimating Dividends:Sp
13、ecial CasesCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.If dividends are expected at regular intervals forever,then this is a perpetuity,and the present value of expected future dividends can be fo
14、und using the perpetuity formula.P0=D/R Suppose a stock is expected to pay a$0.50 dividend every quarter and the required return is 10%with quarterly compounding.What is the price?P0=.50/(.1/4)=$20Zero GrowthCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution wit
15、hout the prior written consent of McGraw-Hill Education.Dividends are expected to grow at a constant percent per period.P0=D1/(1+R)+D2/(1+R)2+D3/(1+R)3+P0=D0(1+g)/(1+R)+D0(1+g)2/(1+R)2+D0(1+g)3/(1+R)3+With a little algebra and some series work,this reduces to:Dividend Growth Modelg-RDg-Rg)1(DP100Cop
16、yright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Suppose Big D,Inc.,just paid a dividend of$0.50 per share.It is expected to increase its dividend by 2%per year.If the market requires a return of 15%on as
17、sets of this risk,how much should the stock be selling for?P0=.50(1+.02)/(.15-.02)=$3.92DGM Example 1Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Suppose TB Pirates,Inc.,is expected to pay a$2 divi
18、dend in one year.If the dividend is expected to grow at 5%per year and the required return is 20%,what is the price?P0=2/(.2-.05)=$13.33 Why isnt the$2 in the numerator multiplied by(1.05)in this example?DGM Example 2Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distrib
19、ution without the prior written consent of McGraw-Hill Education.Stock Price Sensitivity to Dividend Growth,g05010015020025000.050.10.150.2Stock PriceGrowth RateD1=$2;R=20%Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of Mc
20、Graw-Hill Education.Stock Price Sensitivity to Required Return,R05010015020025000.050.10.150.20.25Stock PriceGrowth RateD1=$2;g=5%Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Gordon Growth Company
21、is expected to pay a dividend of$4 next period,and dividends are expected to grow at 6%per year.The required return is 16%.What is the current price?P0=4/(.16-.06)=$40 Remember that we already have the dividend expected next year,so we dont multiply the dividend by 1+g.Example 8.3:Gordon Growth Comp
22、any-ICopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.What is the price expected to be in year 4?P4=D4(1+g)/(R g)=D5/(R g)P4=4(1+.06)4/(.16-.06)=50.50What is the implied return given the change in pric
23、e during the four year period?50.50=40(1+return)4;return=6%PV=-40;FV=50.50;N=4;CPT I/Y=6%The price is assumed to grow at the same rate as the dividends.Example 8.3:Gordon Growth Company-IICopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior writt
24、en consent of McGraw-Hill Education.Suppose a firm is expected to increase dividends by 20%in one year and by 15%in two years.After that,dividends will increase at a rate of 5%per year indefinitely.If the last dividend was$1 and the required return is 20%,what is the price of the stock?Remember that
25、 we have to find the PV of all expected future dividends.Nonconstant Growth Example-ICopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Compute the dividends until growth levels off.D1=1(1.2)=$1.20 D2=1.
26、20(1.15)=$1.38 D3=1.38(1.05)=$1.449 Find the expected future price.P2=D3/(R g)=1.449/(.2-.05)=9.66 Find the present value of the expected future cash flows.P0=1.20/(1.2)+(1.38+9.66)/(1.2)2=8.67Nonconstant Growth Example-IICopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or di
27、stribution without the prior written consent of McGraw-Hill Education.What is the value of a stock that is expected to pay a constant dividend of$2 per year if the required return is 15%?What if the company starts increasing dividends by 3%per year,beginning with the next dividend?The required retur
28、n stays at 15%.Quick Quiz Part ICopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Start with the DGM:Using the DGM to Find RgPD gPg)1(D Rg-RDg-Rg)1(DP0100100Copyright 2019 McGraw-Hill Education.All righ
29、ts reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Suppose a firms stock is selling for$10.50.It just paid a$1 dividend,and dividends are expected to grow at 5%per year.What is the required return?R=1(1.05)/10.50+.05=15%What is the dividend yield?1
30、(1.05)/10.50=10%What is the capital gains yield?g=5%Example:Finding the Required Return Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Another common valuation approach is to multiply a benchmark PE
31、ratio by earnings per share(EPS)to come up with a stock price.Pt=Benchmark PE ratio EPSt The benchmark PE ratio is often an industry average or based on a companys own historical values.The price-sales ratio can also be used.Stock Valuation Using MultiplesCopyright 2019 McGraw-Hill Education.All rig
32、hts reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Suppose a company had earnings per share of$3 over the past year.The industry average PE ratio is 12.Use this information to value this companys stock price.Pt=12$3=$36 per shareExample:Stock Valu
33、ation Using Multiples Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Table 8.1 Stock Valuation Summary(1)Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution witho
34、ut the prior written consent of McGraw-Hill Education.Table 8.1 Stock Valuation Summary(2)Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Voting Rights Proxy voting Classes of stock Other Rights Share
35、 proportionally in declared dividends Share proportionally in remaining assets during liquidation Preemptive right first shot at new stock issue to maintain proportional ownership if desiredFeatures of Common StockCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distributi
36、on without the prior written consent of McGraw-Hill Education.Dividends are not a liability of the firm until a dividend has been declared by the Board.Consequently,a firm cannot go bankrupt for not declaring dividends.Dividends and Taxes Dividend payments are not considered a business expense;there
37、fore,they are not tax deductible.The taxation of dividends received by individuals depends on the holding period.Dividends received by corporations have a minimum 70%exclusion from taxable income.Dividend CharacteristicsCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or dist
38、ribution without the prior written consent of McGraw-Hill Education.Dividends Stated dividend that must be paid before dividends can be paid to common stockholders Dividends are not a liability of the firm,and preferred dividends can be deferred indefinitely.Most preferred dividends are cumulative a
39、ny missed preferred dividends have to be paid before common dividends can be paid.Preferred stock generally does not carry voting rights.Features of Preferred StockCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hil
40、l Education.Dealers vs.Brokers New York Stock Exchange(NYSE)Largest stock market in the world License holders(1,366)Designated market makers(DMMs)Floor brokers Supplemental liquidity providers(SLPs)Operations Floor activityStock MarketCopyright 2019 McGraw-Hill Education.All rights reserved.No repro
41、duction or distribution without the prior written consent of McGraw-Hill Education.Not a physical exchange computer-based quotation system Multiple market makers Electronic Communications Networks Three levels of information Level 1 median quotes,registered representatives Level 2 view quotes,broker
42、s,and dealers Level 3 view and update quotes,dealers only Large portion of technology stocksNASDAQCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Electronic Communications Networks provide trading in
43、NASDAQ securities.To see more detail,visit Instinet.Work the Web ExampleCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.Reading Stock Quotes What information is provided in the stock quote?You can go
44、to Bloomberg for current stock quotes.Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.You observe a stock price of$18.75.You expect a dividend growth rate of 5%,and the most recent dividend was$1.50.W
45、hat is the required return?What are some of the major characteristics of common stock?What are some of the major characteristics of preferred stock?Quick Quiz Part IICopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-H
46、ill Education.The status of pension funding(i.e.,over-vs.under-funded)depends heavily on the choice of a discount rate.When actuaries are choosing the appropriate rate,should they give greater priority to future pension recipients,management,or shareholders?How has the increasing availability and us
47、e of the internet impacted the ability of stock traders to act unethically?Ethics IssuesCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.XYZ stock currently sells for$50 per share.The next expected ann
48、ual dividend is$2,and the growth rate is 6%.What is the expected rate of return on this stock?If the required rate of return on this stock were 12%,what would the stock price be,and what would the dividend yield be?Comprehensive ProblemCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.End of Chapter Chapter 8Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.
