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Chapter Objectives
To understand the concept of stock return and
valuation
To understand the constant growth model To explain the two stage growth model To understand the concept of price-earnings ratio To explain the concept of preferred stock
valuation
Anticipated Return
It is the expected rate of return an investor will
get in future on his investments. The anticipated rate of return can be calculated with the help of probability. Probability refers to the likelihood occurrence of an event. It can be calculated as:
E(R) = (Probability Pt ) (Return R t )
t=1 N
multiple year holding period. The formula for calculating the multiple year holding period is as follows:
N [(e0 )d / e] (1 + g)n (P / E) [ (e0 )(1 + g) N + 1 ] P0 = + (1 + r) n (1 + r) N n = 1
where g = annual expected growth in earnings, dividends and price e = most recent earnings per share d / e = dividend pay out r = required rate of return P / E = price-earnings ratio N = holding period in years
It is calculated as:
D0 (1 + g s ) t D N+1 1 P0 = + (rs - g n ) (1 + rs ) N (1 + rs ) t t=1
N
where
= Dividend of the previous period = Above normal and normal = = Required rate of return Period of above normal growth
earnings.
The advantages of price earning ratio are as:
It helps in comparing the stock prices that have
where
Chapter Summary
By now, you should have:
Understood the concept of stock return and
valuation
Understood the constant growth model Learnt the two stage growth model Understood the concept of price-earnings ratio Understood the concept of preferred stock
valuation