Stock Valuation

Session-10
Unit 10.1
 Key Points
To understand different stock valuation model to estimate stock price
01

To be able to explain how one would find the value of stock with constant dividend
02 growth.

To be able to explain how one would find the value of a stock with zero growth
03

To be able to explain how one would find the value of a supernormal growth
04 stock
 Dividend Discount Model
 Value of a stock is the present value of the future
dividends expected to be generated by the stock
 This model is known as Dividend Discount
Model (DDM)
^ D1 D2 D3 D
P0  1
 2
 3
 ... 
(1  rs ) (1  rs ) (1  rs ) (1  rs ) 
 Constant growth stock
• Still, for many companies it is reasonable to predict that
dividends will grow at a constant rate.
• If g is constant, the dividend growth formula converges to

^ D 0 (1  g) D1
P0  
rs - g rs - g
 What happens if g > rs?
 If g > rs, the constant growth formula leads to a
negative stock price, which does not make sense
 The constant growth model can only be used if:
rs > g
g is expected to be constant forever
 Example
If D0 = $2 and g is a constant 6%, required rate of return is
13% find the expected dividend stream for the next 3 years,
and their PVs. 0 g = 6% 1 2 3

D0 = 2.00 2.12 2.247 2.382

1.8761
rs = 13%
1.7599
1.6509
What is the stock’s intrinsic value?
What is the expected market price of the stock, one year from now
D1 will have been paid out already. So, P1 is the present value (as of
year 1) of D2, D3, D4, etc.

Could also find expected P1 as

^
P1  P0 (1.06)  $32.10
What are the expected dividend yield, capital gains
yield, and total return during the first year?
What are the expected dividend yield, capital gains
yield, and total return during the first year?
 References
1.Financial Management Theory and Practice by
BE [Brigham, E. F., & Ehrhardt, M. C.] (Chapter
8)
2.Fundamentals of financial management by BH
[Brigham, E. F., & Houston, J. F.] (Chapter 9)
Thank you