STOCK / SHARES / SECURITIES VALUATION

Present Dividend = D0
Future forecast dividend for next year = D 1
Present stock price = P0
Future stock price for next year = P1
Expected rate of return = r

Expected rate of return = dividend yield = r = D 1 / P0

Capital Gain = r = P1 - P0 / P0
Expected rate of return = r = D1 / P0 + P1 - P0 / P0
Or r = D1 + P1 - P0 / P0
Or r = D1 + P1 - P0
P0
For example;

1. Suppose Blue Skies stock is selling for $75 a share at present and investors expect a $3 cash dividend over the
next year. They also expect the stock to sell for $81, a year hence (P1 = $81). Then the expected return to
shareholders is ? (Ans. 0.12 or 12%).

2. Calculate present value of cash flow/today’s price for Blue Skies if DIV1 = $3
and P1 = $81. If stocks of similar risk offer an expected return of 12%.
(Ans. $75).

3. X Manufacturing Co. is increasing next year’s dividend to $5 per share.

The forecast stock price next year is $105. Equally risky stocks of other
companies offer expected rates of return of 10%.
What should X Co. common stock sell for? (Ans. $100).

4. If Mehboob Public Ltd. is planning to pay first annual dividend Rs. 30 and the stock of
similar risk offer an expected rate of return is 15%. The shareholders also expecting
to sell their stock at Rs. 120 a year hence.
What is the today’s price of stock for Mehboob Public Ltd. (Ans- Rs.130.4)
 DIVIDEND DISCOUNT MODEL
When all future forecast dividend are paid without expecting future forecast price of stock …….

P0 = D1 + D2 + D3 + …. DH + PH
(1+r)1 (1+r)2 (1+r)3 (1+r)H
H = Time horizon

1. Current forecasts are for XYZ Company to pay dividends of $3, $3.24, and $3.50 over the next three years,
respectively. At the end of three years you anticipate selling your stock at a market price of $94.48.
What is the price of the stock given a 12% expected return? (Ans. $75)
Data:
D1 = $3, D2 = $3.24, D3 = $3.50 P3 = $94.48, r = 12% , Po = ?

P0 = D1 + D2 + D 3 + P3
(1+r)1 (1+r)2 (1+r)3

P0 = 3 + 3.24 + 3.50 + 94.48

(1+0.12)1 (1+0.12) 2 (1+0.12)3

P0 = 2.678571 + 2.582908 + 69.74023

P0 = $75

2. Suppose Iqbal Brs. Intends to buy a stock for 2 years of Mehboob Public Ltd, which is expected to grow at a
constant rate of 10% (both the stock price and the dividend). The shareholders are expecting dividend of Rs.
40 and a stock price Rs. 120 a year hence. What price Iqbal Brs. Would willing to pay at present for Mehboob
Public Ltd. Stock? (Ans. 181.80)
Data:
D1 = Rs. 40 ; P1 = Rs. 120 ; D2 = Rs. 44 ; P2 = Rs. 132; D2 = 40 + (40x10%) = 40+4 = 44
OR D2 = PV(1+r)n
P0 = D1 + D 2 + P3
(1+r)1 (1+r)2 D2 = 40(1+10%)1 = 44
P2 = 120(1+10%)1 = 132
P0 = 40 + 44 + 132
(1+0.10)1 (1+0.10)2

P0 = 36.36364 + 145.4545

P0 = Rs. 181.8182
 ZERO GROWTH OR NO GROWTH DIVIDEND (PERPETUITY)
When a firm or company pays out all its earnings as dividend to shareholders, such dividend is said to be zero growth

Stock value or Price = Perpetuity = P 0 = D1 / r ------ Zero growth OR P0 = EPS1 / r

If growth is given:
P0 = D1 / r - g ------ if there is growth

1. Anwer Public Ltd. has no growth for the past 10 years because it earns Rs. 120 per share and pays it all out to
stockholders. The stockholders have alternative equivalent risk ventures yielding at 30% per year on average.
What is the worth of one share of Anwer Public Ltd. (Ans-Rs. 400)

DATA
D1 or EPS = Rs. 120, r = 30% or 0.30, Worth of one share = P 0 = ?

P0 = EPS1 OR D1 / r

P0 = 120 / 0.30

P0 = Rs. 400

2. Our company forecasts to pay a $5 dividend next year, which represents 100% of its earnings. This will
provide investors with a 12% expected return. Instead, we decide to plowback 40% of the earnings of the
firm’s current return on equity of 20%. What is the value of the stock before and after the plowback decision?
(No growth Ans-$41.67) (but with growth Ans- g= 8% and P 0 = $75) (plowback = retain earnings)

DATA
D1 = $5, r = 12% or 0.12, Value of stock before growth = P0 = ?

P0 = D1 / r ……. Zero growth

P0 = 5 / 0.12

P0 = $41.67

DATA
D1 = $5 x (=100%-40%=60%) = $3, r = 12% or 0.12, Value of stock after plowback = P0 = ?

Growth: If any amount is retained or reinvested or plowback out of earnings

When growth is given: P0 = D1 / r-g Growth = plowback x current rate on equity

= 40% x 20% = 8% or 0.08.
P0 = D1 / r-g = 3 / 12% - 8%
= 3/0.04 P0 = D1 / r-g = 3 / 12% - 8%
P0 = $75 = 3/0.04
= $75
 CONSTANT GROWTH (Gordon Growth Model)

Growth: If any amount is retained or reinvested or plowback out of earnings

When growth is given: P0 = D1 / r-g

1. Altaf Public Ltd. has just paid a dividend. The next forecasted dividend, to be paid in next year is Rs. 15 with
the growth rate of dividend is 8% and the discount rate is 11%. What is the present value of the stock (Ans. Rs.
500).

DATA
D1 = Rs. 15; g = 8%; r = 11% or 0.11; Value of stock after plowback = P0 = ?

P0 = D1 / r-g

P0 = 15 /11% - 8%

P0 = 15 /3%

P0 = Rs. 500
 NON-CONSTANT GROWTH

P0 = D1 + D2 + D3 + …. DH + PH
(1+r)1 (1+r)2 (1+r)3 (1+r)H
H = Time horizon

1. Zee Company estimates to pay dividends of $6, $7, $7.5 and $9 over the next four years, respectively. At the
end of four years you anticipate selling your stock at a market price of $112. What is the price of the stock
given a 10% expected return? (Ans-$99.5)

P0 = D1 + D2 + D3 + D4 + P4
1 2 3
(1+r) (1+r) (1+r) (1+r)4

P0 = 6 + 7 + 7.5 + 9 + 112
(1+0.1)1 (1+0.1)2 (1+0.1)3 (1+0.1)4

P0 = $99.51
 PRICE EARNING RATIO

1. The Iqbal Public Ltd. earns at its stock Rs. 11.21 with current stock price is Rs. 57.56. What is the price earnings
ratio of the company? (Ans – Rs. 5.134)

Price Earnings Ratio = Stock Price or Po / EPS (Earnings per share)

Or P/E = Po / EPS

EPS = Earnings After Taxes or Operating Profit / No. of shares or stock (outstanding stock)

P/E = Po / EPS

P/E = 57.56 / 11.21

P/E = Rs. 5.13

2. ABC firm is forecasting its next year’s dividend Rs. 75 with an expected rate of return 14%. Firm’s operating
profit for the year is Rs. 2,000,000 and its balance sheet indicates 100,000 outstanding shares. You are
required to calculate P/E for ABC Firm.

Hint: Firstly you need to calculate current year price and then earnings per share.

P/E = Po / EPS

P0 = D1 / r
P0 = 75 / 0.14
P0 = 535.71

EPS = Operating profit / outstanding shares

EPS = 2,000,000 / 100,000
EPS = 20

P/E = 535.71 / 20

P/E = 26.8