Professional Documents
Culture Documents
Equities - Fundamentals
Contents
1. Equity markets
2. Equity valua6on
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B1. Equity markets
• Real versus Financial assets
− Real assets: those assets that can be used to produce goods and service
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Land, buildings, machines, knowledge, etc
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Generate net income to the economy
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B1. Equity markets
• Equi6es
− The most basic of financial instruments is the equity (aka stock or share)
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You could raise capital and launch a company by selling off future
profits in the form of a stake in the company
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Once your business is up and running, you could raise further capital
by issuing new shares
− Once the small business has become large, shares in the company may be
sold to a wider audience or even the general public
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B1. Equity markets
• Equi6es
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B1. Equity markets
• Common versus preferred stocks
− Common stock usually en6tles the owner the right to vote at shareholder
mee6ngs and to receive dividends
II. residual claim: stockholders are the last in line of all those who have a
claim on the assets and income of the corpora6on
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B1. Equity markets
• Common versus preferred stocks
− Preferred stock has a prior claim on any dividend paid by the company and
to the net assets in the event of liquida6on
− Newly issued claims are exchanged on the primary market with funds flowing
from the investors to the issuers
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B1. Equity markets
• Securi6es Trading
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B1. Equity markets
• Securi6es Trading
Buying on margin:
– The ini6al margin is the por6on of the purchase price that must be
contributed by the investor
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B1. Equity markets
• Securi6es Trading: MARGIN TRADING EXAMPLE
€22 Purchase Price 1000 Shares Purchased
50% Ini6al Margin 40% Maintenance Margin
Ini6al Posi6on
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B1. Equity markets
• Securi6es Trading
Short Sale:
– The investor will need to buy these back on the market to return them
to the lender
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B1. Equity markets
• Securi6es Trading: SHORT SELLING EXAMPLE
€22 Ini6al Price 1000 Shares borrowed & shorted
50% Ini6al Margin 30% Maintenance Margin
Ini6al Posi6on
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B1. Equity markets
• Securi6es Trading
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Bid price: the price at which a market-maker or dealer is prepared to
buy securi6es or other assets
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Ask price: the price at which a market-maker or dealer is prepared to
sell securi6es or other assets
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B2. Equity valua6on
Equity Valua@on
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B2. Equity valua6on
• Equity valua6on
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B2. Equity valua6on
• Equity valua6on models
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Is this stock value “correct”?
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What assump6ons could jus6fy this value?
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Is this market behavior consistent with a ra6onal valua6on model
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B2. Equity valua6on
• Valua6on approaches
− ValuaFon by comparables
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The basic premise is that an equity’s value should present some
resemblance to other equi6es in a similar class
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B2. Equity valua6on
• Valua6on by comparables
− The method of comparables is the most widely used approach for analysts
repor6ng valua6on judgments
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B2. Equity valua6on
• Valua6on by comparables
− The term price mul@ple refers to a ra6o that compares the share price with
some sort of monetary flow or value to allow evalua6on of the rela6ve
worth of a company’s stock
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B2. Equity valua6on
• Valua6on by comparables
− Iden6fying individual companies or even an industry as the “comparable”
may present a challenge
− The analyst should be careful to iden6fy companies that are most similar
according to a number of dimensions
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overall size
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product lines
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growth rate
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etc
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B2. Equity valua6on
• Valua6on by comparables
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B2. Equity valua6on
• Valua6on by comparables
− Earnings per share (EPS) is calculated as the company’s profit divided by the
outstanding shares of its common stock
− P/E is arguably the price mul6ple most frequently cited by the media and
used by analysts and investors
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B2. Equity valua6on
• Valua6on by comparables
− Price to Book raFo (P/B): it is the ra6o of the stock price to book value per
share
− Price-to-sales raFo (P/S): this measure is the ra6o of stock price to sales per
share
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B2. Equity valua6on
• Valua6on by comparables
− A common cri6cism of all of these mul6ples is that they do not consider the
future
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B2. Equity valua6on
• Price-earnings ra6o
− Example:
• The stock was then trading at €68 and over 80% of analysts had a buy
or overweight recommenda6on
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B2. Equity valua6on
• Price-earnings ra6o
– The analyst must decide whether he/she is more or less op6mis6c than the
market
– The PER is also used as a compara6ve valua6on ra6o to comment about the
rela6ve valua6on of firms within the same industry
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Concrete Case - Nyrstar
Analysts Recommenda6ons
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B2. Equity valua6on
• Dividend discount models
− Dividends are lump sum payments, paid out to the stock holder
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B2. Equity valua6on
• The 6me value of money
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B2. Equity valua6on
• Appendix: Present and Future value
− Present value: is the amount that you would need to invest today to build
up certain future cash flow
− Present value provides a basis for assessing the fairness of any future
financial benefits or liabili6es
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B2. Equity valua6on
• Appendix: Present and Future value
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Value in 1 year = 100 € ∗ ( 1+0.08 )=108 €
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Value in 2 years = 100 € ∗ ( 1+0.08 ) ∗ ( 1+0.08 )=108 € ∗ ( 1+0.08 ) =100 € ∗ ( 1+ 0.08 )2=116.64 €
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Value in n years = 100 € ∗ ( 1+0.08 ) ∗ ( 1+0.08 ) ∗ ...∗ ( 1+0.08 ) =100 € ∗ ( 1+0.08 )
n
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B2. Equity valua6on
• Appendix: Present and Future value
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B2. Equity valua6on
• Appendix: Present and Future value
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PV =100 € / ( 1.10 ) =82.64 €
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B2. Equity valua6on
• Appendix: Present and Future value
− Remarks:
I. The higher the interest rate, the lower the present value
II. The longer the 6me un6l the cash flow, the lower the present value
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B2. Equity valua6on
• Present value models
− These models assume that the stock is bought, held for some 6me and then
sold
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B2. Equity valua6on
• Dividend Discount Models
− The intrinsic value of a share is the present value of the dividend to be
received at the end of the first year and the expected sales price
− Hence,
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B2. Equity valua6on
• Dividend Discount Models
− Since the price at which you can sell a stock in the future depends on
dividend forecast at that 6me, we can say that
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B2. Equity valua6on
• Dividend Discount Models
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B2. Equity valua6on
• Dividend Discount Models
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B2. Equity valua6on
• Dividend Discount Models
Growing Perpetuity
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B2. Equity valua6on
• Dividend Discount Models
− MulFstage growth model:
• Growth rates are generally not constant
• Analysts prefer determining the intrinsic value by:
− forecas6ng dividends over a given 6me horizon
− assuming constant growth therearer
D1 D2 D3 Dt + Vt
V0 = + + + ... +
1 + k (1 + k ) 2 (1 + k ) 3 (1 + k ) t
Dt (1 + g )
Vt =
k−g
Dividends aSer @me t are assumed to have a constant growth rate of g
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Exercise 1
• Suppose that the expected dividends for the next three years are given
as follow:
Year Dividend
1 100$
2 120$
3 150$
After the third year dividends are expected to grow 5% a year forever
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Exercise 1
a. What is the intrinsic value if the appropriate rate of return is 10%.
b. What is the expected sale price at t = 3, right after the third year
dividend payment?
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Exercise 2
• Dividend Discount Models
− Example of DDM using a capitaliza6on rate:
AssumpFons
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Exercise 2
• Dividend Discount Models
− Example of DDM using a capitaliza6on rate:
t 1 2 3 4 5
Cash Flow
Growing Perpetuity
Discount Factor
CF Present Value
Intrinsic Value =
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