HOA SEN UNIVERSITY

FACULTY OF ECONOMICS AND COMMERCE

1
CORPORATE FINANCE

CHAPTER 4
STOCKS VALUATION

2
 Chapter 4: STOCKS VALUATION
• Main Contents:
1. Stocks and Stock market
2. Market values, Book values, and
Liquidation values
3. Valuing Common stocks
4. Simplifying the dividend discount model
5. Growth stocks and Income stocks
6. Technical and Fundamental analysis

3
I. STOCK AND STOCK MARKET

IPO

…sell shares to the public in the first time

Common stocks

Primary market

Secondary market

4
I. STOCK AND STOCK MARKET
(cont’d)

•Computer network connects stock traders

•Scope of stock market: worldwide

Tanzanian New York

stock exchange stock exchange 5
 I. STOCK AND STOCK MARKET
(cont’d)

Characteristics of shares trades

•…transferring ownership from one shareholder to others

•…no new shares are created

•…share issuer does not know the stock trade

•…The buyer and seller place the order through brokerage firms

•…stock trading can be a risky investment

6
 II. MARKET, BOOK, AND
LIQUIDATION VALUE
Book value

Book value of the Value of assets in Liabilities in balance

= -
firm’s equity balance sheet sheet

…is a net worth of the firm according to the balance sheet

…express all the money raised from the shareholders plus all the
retained earning

7
 II. MARKET, BOOK, AND
LIQUIDATION VALUE (cont’d)
Liquidation value

…net proceeds that could be realized by selling the firm’s assets and
paying off its creditors

…a successful company has its worth more than its liquidation value.

8
 II. MARKET, BOOK, AND
LIQUIDATION VALUE (cont’d)
??? Why is it existed the difference between company’s actual value and
its book or liquidation value ?

Extra earning power

Intangible assets

9
Value of future investment
 II. MARKET, BOOK, AND
LIQUIDATION VALUE (cont’d)
Market value

•…the amount that investors are willing to pay for the shares of the firm.

•…depends on the earning power of today’s assets and the expected

profitability of future investment

•Market value balance sheet: financial statement that uses the market
value of all A&L

10
 III. VALUING COMMON STOCKS
Valuation by comparables

•Steps to valuate common stocks:

1 Divide stock price by assets or earning

2 See the relations with other firms in the same industry

11
 III. VALUING COMMON STOCKS
(cont’d)

Valuation by comparables (cont’d)

•Steps to valuate common stocks (cont’d):

•…the method of price-to-book value ratio works well for company with plenty12
of fixed assets, but poorly for that with the intangible assets
 III. VALUING COMMON STOCKS
(cont’d)

Price and intrinsic value

Valuation by cash flow

Key concept
PV of future CFs from equity

CFs stemming from shares:

Dividends (D)
Share price once sold (P)

13
 III. VALUING COMMON STOCKS
(cont’d)

Price and intrinsic value

•Compare the cash flow of a bond and a stock:

+ Coupon
Cash flow - Face value + Coupon + Coupon + Coupon + face value
of Bond
0 1 2 3 4

+ dividend
- Market price + dividend + dividend + dividend + market price
Cash flow
of Stock 0 1 2 3 4
14
 III. VALUING COMMON STOCKS
(cont’d)

Price and intrinsic value

•Intrinsic value:

…present value of future cash flows from a stock or other security

Investor will receive a cash dividend of $3 next year, and expect to sell
the stock at $81 next year, discount rate is 12%.

What is the intrinsic value of stock (or the price of the stock) ?

V0 = ? d1 + P1

0 1 15
 III. VALUING COMMON STOCKS
(cont’d)

Price and intrinsic value (cont’d)

•Intrinsic value (cont’d):

d 1  P1
v0 
1 r
d 1 P1 V 0
r  
V0 V0

Expected rate of = Expected dividend + Expected capital

return yield gain yield

16
 III. VALUING COMMON STOCKS
(cont’d)

Price and intrinsic value (cont’d)

•Intrinsic value (cont’d):

At each time point, all securities of the same risk are priced to offer
the same expected rate of return

17
 III. VALUING COMMON STOCKS
(cont’d)

The dividend discount model

+ dh
P0 = ? + d1 + d2 … + Ph

0 1 2 … h

d1 d2 d h  Ph
P0    ... 
1  r 1  r 2
1  r h 18
 III. VALUING COMMON STOCKS
(cont’d)

The dividend discount model (cont’d)

Dividend discount model: today’s stock price equals the present value
of all expected futures

The stock value will be the same regardless of the investment horizon

19
 III. VALUING COMMON STOCKS
(cont’d)

The dividend discount model (cont’d)

Three investors have a plan to invest in one corporation but different horizons:

The stock price and the dividend increase 8% per year, and the expected return is 12%

What is the price of the stock for each of three investors ? 20

 III. VALUING COMMON STOCKS
(cont’d)

The dividend discount model (cont’d)

21
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL
The dividend discount model with no growth

Stock price ? + dividend + dividend + dividend + dividend ……….

0 1 2 3 4 ………

…company have no growth due to no reinvestment

…the stream of equal cash payments creates perpetuity

d
P0 
r 22
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
The dividend discount model with no growth (cont’d)

• Company pay all its earning to common shareholders

•…and the earning can be maintained for good

EPS
P0 
r

23
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
The constant growth dividend discount model

Stock price ? + d1 + d1(1+g) + d1(1+g)2 + d1(1+g)3 ……….

0 1 2 3 4 ………

d1 d 1 (1  g ) d 1 (1  g )2 d 1 (1  g )3
P0      ...
1 r 1 r 1 r 1 r
d1 •d = dividend in year 1.
 P0  1
•r = discounted rate. 24
r g •g = expected growth rate of dividend
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
The constant growth dividend discount model (cont’d)

Tay Thi company will pay a $3 dividend in 1 year. If the dividend grows at a
constant rate of g= 8%, and discount rate is 12%.

What is the stock value of the company ?

25
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
The constant growth dividend discount model (cont’d)

d1
P0 
r g

??? What happen if the growth rate of dividend higher than investor’s required return ?

1. The formula explode !!!

2. The forecast is wrong due to the far-distant dividends with always

incredibly high present values
26
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
Estimating Expected Rate of Return

…common stocks with the same risk are priced to offer the same expected
rate of return

Based on constant growth dividend discount model

d1
P0 
r g
d1
r  g
P0

Estimated expected = Dividend + Growth rate of

rate of return yield dividend 27
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
Estimating Expected Rate of Return (cont’d)

TYPN company will pay a $4 dividend this year. If the dividend grows at a
constant rate of g= 6%, and its stock price is $80.

What is the expected rate of return ?

28
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
Estimating Expected Rate of Return (cont’d)

??? Which factors affect on the expected rate of return ?

…only the risk of the stock (not any others: growth rate of dividend, or dividend payment…)

??? How can the price of stock be determined based on the risk ?

1 Selecting another stock with the same risk

2 Determine the expected rate of return of selected stock

3 Calculate the stock price by predetermine d and g

29
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
Estimating Expected Rate of Return (cont’d)

TYPN company will pay a $4 dividend this year. If the dividend grows at a
constant rate of g= 6%. The TYPN have the same risk of ABC company with
the expected rate of return is 10%

Determine the stock price of the TYPN ?

30
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
Non constant growth

Stock price ? + d1 + d2 ….. + dh + P h

0 1 2 …. 4

d1 d2 dh Ph
P0   2
 ...  h

1  r (1  r ) (1  r ) (1  r )h

•Ph = expected stock price in the year h

31
 IV. SIMPLIFYING THE DIVIDEND
DISCOUNT MODEL (cont’d)
Non constant growth (cont’d)

In late 2007, the share price of PepsiCo’s stock was about $72. The company
earned about $3.4 a share, and paid out about 40% of earning for dividend

Investors forecasted the earnings would grow over next 5 years by 11.5% a year,
and the growth rate of dividend 6% in the year 6 and lasting forever.
The expected rate of return is 10%

Determine the stock price of the PepsiCo ?

32
 VI. GROWTH STOCKS and
INCOME STOCKS

Growth stocks

…invested primarily for expectation of the capital gains, future growth

of earnings

Income stocks

…invested primarily for cash dividends

33
V. GROWTH STOCKS and
INCOME STOCKS (cont’d)
Earning
1
Shares

2  ROE x book equity per share

EPS
Payout ratio
%
…fraction of earnings paid out as dividend

%
Plowback ratio

34
…fraction of earnings reinvested in the firm
 V. GROWTH STOCKS and
INCOME STOCKS (cont’d)
Sustainable growth rate

…the rate of growth that the company can sustain from reinvested earnings

Sustainable growth rate

= ROE x Plowback ratio
(g)

…no plowback ratio means no sustainable growth rate

•…plowing earnings back into new investments may result in growth in

earning and dividends, but does not add the current stock price

35
 V. GROWTH STOCKS and
INCOME STOCKS (cont’d)

Value of the asset in place (no reinvestment) (1) $41.67

Total value of stock (reinvestment) (2) $75

Present value of growth opportunities (PVGO) (2)-(1) $33.33

36
Thank you for your attention !

37