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# 10 - 1

CHAPTER 10
Stocks and Their Valuation

##  Features of common stock

 Determining common stock
values
 Preferred stock

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## Facts about Common Stock

 Represents ownership.
 Ownership implies control.
 Stockholders elect directors.
 Directors hire management.
 Management’s goal: Maximize
stock price.
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offering (IPO)?

##  A firm “goes public” through an IPO

when the stock is first offered to the
public.
 Prior to an IPO, shares are typically
owned by the firm’s managers, key
employees, and, in many situations,
venture capital providers.

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## Stock Value = PV of Dividends

 = D1 D2 D3 D∞
P + + +. . .+
0
(1 + k ) (1 + k ) (1 + k )
s
1
s
2
s
3
(1 + k ) s

## One whose dividends are expected to

grow forever at a constant rate, g.
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## For a constant growth stock,

D1 = D 0 (1 + g)
1

D 2 = D 0 (1 + g)
2

D t = D t (1 + g)
t

If g is constant, then:
P = D 0 (1 + g) =
D1
0
ks − g ks − g
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## What happens if g > ks?

 D
P0 = 1
requires k s > g.
ks − g
 If ks< g, get negative stock price,
which is nonsense.
 We can’t use model unless (1) g < ks
and (2) g is expected to be constant
forever. Because g must be a long-
term growth rate, it cannot be > ks.
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## Assume beta = 1.2, kRF = 7%, and kM =

12%. What is the required rate of
return on the firm’s stock?

## ks = kRF + (kM - kRF)bFirm

= 7% + (12% - 7%) (1.2)
= 13%.

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## D0 was \$2.00 and g is a constant 6%.

Find the expected dividends for the
next 3 years, and their PVs. ks = 13%.

0 g=6% 1 2 3 4

## D0=2.00 2.12 2.2472 2.3820

1.8761 13%
1.7599
1.6508

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What’s the stock’s market value?
D0 = 2.00, ks = 13%, g = 6%.

P 0 =
D 0 (1 + g) =
D1

ks − g ks − g
\$2.12 \$2.12
= = \$30.29.
0.13 - 0.06 0.07
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## What is the stock’s market value one

^
year from now, P 1?

##  D1 will have been paid, so expected

dividends are D2, D3, D4 and so on.
Thus,
D2
P̂1 =
ks − g
\$2.2472
= = \$32.10.
0.07

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## Find the expected dividend yield and

capital gains yield during the first year.

D1 \$2.12
Dividend yield = = = 7.0%.
P0 \$30.29

^
P1 - P 0 \$32.10 - \$30.29
CG Yield = =
P0 \$30.29
= 6.0%.
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first year.

##  Total return = Dividend yield +

Capital gains yield.
 Total return = 7% + 6% = 13%.
Total return = 13% = ks.
 For constant growth stock:
Capital gains yield = 6% = g.
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## Rearrange model to rate of return form:

 D  D
P0 = 1
to k s = 1
+ g.
ks − g P0

^
Then, ks = \$2.12/\$30.29 + 0.06
= 0.07 + 0.06 = 13%.

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What would P0 be if g = 0?

perpetuity.
0 k =13% 1 2 3
s

^ PMT \$2.00
P0 = = = \$15.38.
k 0.13
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## If we have supernormal growth of

30% for 3 years, then a long-run
^
constant g = 6%, what is P0? k is
still 13%.

##  Can no longer use constant growth

model.
 However, growth becomes constant
after 3 years.

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growth:
0 k =13% 1 2 3 4
s

## g = 30% g = 30% g = 30% g = 6%

D0 = 2.00 2.60 3.38 4.394 4.6576

2.3009
2.6470
3.0453
\$4.6576
P̂3 = = \$66.5371
46.1135 0.13 − 0.06
^
54.1067 = P0
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## What is the expected dividend yield and

capital gains yield at t = 0? At t = 4?

At t = 0:
D1 \$2.60
Dividend yield = = = 4.8%.
P0 \$54.11

(More…)
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##  During nonconstant growth, dividend

yield and capital gains yield are not
constant.
 If current growth is greater than g,
current capital gains yield is greater
than g.
 After t = 3, g = constant = 6%, so the t
t = 4 capital gains gains yield = 6%.
 Because ks = 13%, the t = 4 dividend
yield = 13% - 6% = 7%.
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## Is the stock price based on

short-term growth?
 The current stock price is \$54.11.
 The PV of dividends beyond year 3 is
\$46.11 (P
^ 3 discounted back to t = 0).
 The percentage of stock price due to
“long-term” dividends is:
\$46.11
\$54.11 = 85.2%.
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## Suppose g = 0 for t = 1 to 3, and then g

is a constant 6%. What is ^P0?

0 1 2 3 4
ks=13%
...
g = 0% g = 0% g = 0% g = 6%
2.00 2.00 2.00 2.12

1.7699
1.5663
P = 2.12 = 30.2857
1.3861
20.9895 3
25.7118 0.07
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## What is dividend yield and capital

gains yield at t = 0 and at t = 3?

D1 2.00
t = 0: P = \$25.72= 7.8%.
0

## t = 3: Now have constant growth

with g = capital gains yield = 6% and
dividend yield = 7%.
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## If g = -6%, would anyone buy the

stock? If so, at what price?

## Firm still has earnings and still pays

^
dividends, so P0 > 0:
D 0 ( 1 + g) D1
P̂0 = =
ks − g ks − g
\$2.00(0.94) \$1.88
= = = \$9.89.
0.13 - (-0.06) 0.19
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## What are the annual dividend

and capital gains yield?

= 19.0%.

## Both yields are constant over time, with

the high dividend yield (19%) offsetting
the negative capital gains yield.
Estimate Stock Price 10 - 24
 Dividend Valuation Model (DVM)
 P/E Multiple Value : วิธอี ัตราส่วนราคาต่อกำาไรต่อหุ้น
อัตราส่วนราคาต่อกำาไรต่อหุ้น(P/E Ratio) = ราคาตลาดต่อหุ้น / กำาไรต่อหุ้น = Price / EPS
ราคาตลาดต่อหุ้น (Price) = P/E Ratio x กำาไรต่อหุ้น
 Book Value : ราคาตามบัญชี
มูลค่าตามบัญชีของหุ้นสามัญรวม=สินทรัพย์รวม-หนี้สินทั้งหมดรวมหุ้นบุริมสิทธิ์
ราคาตามบัญชีต่อหุ้น = มูลค่าตามบัญชีของหุ้นสามัญรวม / จำานวนหุ้นสามัญ
หมายถึง: (สินทรัพย์รวม-หนี้สินทั้งหมดรวมหุ้นบุริมสิทธิ)์ / จำานวนหุ้นสามัญ
 Net Asset Value(NAV)หรือ Liquidation Value
วิธรี าคาตามมูลค่าสินทรัพย์สุทธิ
คล้ายวิธี BV. แต่คำานวณมูลค่าหุ้นสามัญจาก มูลค่าสินทรัพย์ตามราคาตลาด
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## In equilibrium, stock prices are stable.

There is no general tendency for
people to buy versus to sell.
^
The expected price, P, must equal the
actual price, P. In other words, the
fundamental value must be the same as
the price.
(More…)
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## In equilibrium, expected returns must

equal required returns:

^
ks = D1/P0 + g = ks = kRF + (kM - kRF)b.

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## How is equilibrium established?

^
^ D
If ks = 1 + g > ks, then P0 is “too low.”
P0
If the price is lower than the
fundamental value, then the stock is a
“bargain.”

## Buy orders will exceed sell orders, the

^
price will be bid up, and D1/P0 falls until
D /P + g = k = k .
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^ = D1
P0
ki − g

##  ki = kRF + (kM - kRF )bi could change.

 Inflation expectations
 Risk aversion
 Company risk

 g could change.
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Preferred Stock

 Hybrid security.
 Similar to bonds in that preferred
stockholders receive a fixed dividend
which must be paid before dividends
can be paid on common stock.
 However, unlike bonds, preferred
stock dividends can be omitted without
fear of pushing the firm into
bankruptcy.
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## What’s the expected return on

preferred stock with Vps = \$50 and
annual dividend = \$5?

\$5
Vps = \$50 = 
k
ps

 \$5
k ps = = 0.10 = 10.0%.
\$50