Valuation of Stocks 9172021 Fin 307 Stocks Valuation
- Slides: 11
Valuation of Stocks 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 1
Asset Valuation • Asset Value as Present Value of the Cash Flows it will produce: 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 2
Stocks Features • • • Represents (residual) ownership. Ownership implies control. Stockholders elect directors. Directors elect management. Management’s goal: Maximize stock price. Stocks certificate represent proportional ownership. • Stocks certificate entitle its holders to proportional distributions (mainly dividend), if there any. 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 3
The Discounted Dividend Model • A discounted dividend model is any model that computes the value of a share of a stock as the present value of the expected future cash dividends • Using (1) above: Let: P 0 be the present stock price, Dt - Cash dividend per share at time t r – discount rate 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 4
The Discounted Dividend Model • Alternative view of the Model. • Assume a risk less environment • Every investor takes a position in a stock for one period only. • P 1 -the price the next investor will pay for the stock in period 1, after dividend in that period is paid • Repeated substitution will result in (2) 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 5
The Dividend Model • Case 1: Constant Dividend When all dividends are the same D 0 = D 1 = D 2 = …. • The dividend stream is treated as a perpetuity 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 6
Dividend Growth Model • Case 2: Constant Growth Dividend • When dividend grow at constant growth rate g from D 1 and on and g<r (normal growth) • D 2 = D 1(1+g) D 3 = D 2(1+g) = D 1(1+g)2 • The dividend stream is treated as a constant growth perpetuity 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 7
Dividend Growth Model • Case 3: Limited abnormal growth continued by Constant Growth Dividend • Let dividend grow at g 1> r rate for t periods, and from t+1 grow forever at a constant growth rate g 2< r. • Compute (6. 1) Dt+1= Dt (1+ g 2) = D 0(1+ g 1)t (1+ g 2) 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 8
Dividend Growth Model • Which can be substituted with a growing annuity 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 9
Where is Growth Coming from ? • Review: Net Income = Retained earning + Dividend • Retained earning are additions to equity, therefore, next period the increase in NI = ROE * Retained earning • Therefore, growth (7) g= ROE*(Retention Ratio) 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 10
Price and Investment Opportunities • The price of a stock that pays out 100% of its earning : • If the firm decides to retain earning and invest in new project, its value will increase by exactly the projects’ NPV. 9/17/2021 Fin 307 -Stocks Valuation | Dr. Menahem Rosenberg 11
