00 upvote00 downvote

26 visualizações49 páginasEquity Valuation

Oct 16, 2017

© © All Rights Reserved

PPTX, PDF, TXT ou leia online no Scribd

Equity Valuation

© All Rights Reserved

26 visualizações

00 upvote00 downvote

Equity Valuation

© All Rights Reserved

Você está na página 1de 49

Investment Analysis

Instructor: Dr. Leng Ling

Topic: Equity Valuation

1

Learning objectives

1. Distinguish between the intrinsic value and price

of a share of common stock.

2. Calculate the intrinsic value of a firm using

dividend discount models

Constant dividend growth model

Multistage dividend growth model

3. Use the constant growth model to relate growth

opportunities to stock value.

4. Calculate the P/E ratio for a constant growth firm.

5. Discuss the free cash flow valuation methods.

2

Concept Map

Portfolio

Theory

Foreign Asset

Exchange Pricing

FI400

Derivatives Equity

Market Fixed

Efficiency Income

3

Why equity valuation?

Identify mispriced equity securities.

How?

By calculating intrinsic or true value of a

stock using valuation models.

These valuation models make use of

information concerning current & future

profitability.

This approach of identifying mispriced

stocks is called fundamental analysis.

4

Intrinsic value vs. market price (1)

Intrinsic value, V0

Present value of all expected future cash

flows to the stock investor. The cash

flows are discounted at the appropriate

required rate of return, k.

Expected future cash flows consist of:

1. cash dividends

2. sale price: proceeds from the ultimate sale

of the stock

5

Intrinsic value vs. market price (2)

Intrinsic value is your (the analysts)

estimate of what a stock is really worth.

Intrinsic value (V0) can differ from the

current market price (P0).

If V0 > P0: stock is underpriced => buy

If V0 < P0: stock is overpriced => sell or dont

buy.

6

Market equilibrium

In market equilibrium,

Everyone has the same intrinsic value. So,

intrinsic value equals market price, i.e.,

V0 = P0.

Everyone also demands the same required rate

of return from the stock. So everyone has the

same k. In addition, expected HPR = k.

This common required rate of return is called the

market capitalization rate.

Market capitalization rate: required rate of return

which the market (i.e., everyone) uses to discount

future cash flows.

7

Equity valuation models

Dividend discount models

Constant dividend growth model

Multistage (non-constant) dividend growth

model

Price-earnings ratio (P/E)

Free cash flow models

8

Dividend discount models (DDMs)

Dividend discount models say that the

intrinsic value of a stock is equal to the

present value of all expected future

dividends.

What about cash flow from the ultimate sale of

the stock? Is that included?

Yes, because stock price at time of sale is

again determined by expected dividends at

the time of sale.

9

Dividend discount model:

General formula

D1 D2 D3

V0 = + 2

+ 3

+ ....

1 + k (1 + k ) (1 + k )

This formula cannot be implemented because it

requires dividend forecasts every year into the

indefinite future.

To implement the DDM, we make assumptions about

how dividends evolve over time.

10

Two versions of DDM

We look at 2 assumptions:

Dividends grow at constant rate

Constant dividend growth model

Dividends grow at different rates over

different periods. At some future date,

dividend growth settles down to a

constant rate.

Multistage (non-constant) dividend

growth model

11

Constant dividend growth model (1)

1. Assume that dividends grow at a

constant rate, g, per period forever.

2. Given this assumption, the intrinsic value

equals Dont panic.

D0 = Dividend D1 = D0(1 + g)

that the firm

just paid

D0(1 + g) D1

V0 = =

k- g k- g

Required rate Dividend

of return or growth rate

discount rate 12

Constant dividend growth model (2)

Warning: The model works only if k > g.

Useful properties.

All other things unchanged,

If D1 increases (decreases), V0 increases

(decreases).

If g increases (decreases), V0 increases

(decreases).

If k increases (decreases), V0 decreases

(increases).

13

Constant dividend growth model (3)

Suppose the market is in equilibrium. This

means that stock price is equal to intrinsic

value, i.e., P0 = V0.

Then, stock price is expected to grow at

the same rate as dividends.

That is, the expected rate of price

appreciation in any year will equal the

constant growth rate, g.

P1 = P0 ( 1 + g ) = V1 = V0 ( 1 + g )

14

Expected HPR and k (1)

Continue to assume that P0 = V0 .

Then, expected HPR, E(r) is,

D1 P1 - P0

E (r ) = +

P0 P0

D1

= + g

P0

Dividend yield Capital gains yield

15

Expected HPR and k (2)

If stock is selling at intrinsic value, P0 = V0

Then required rate of return, k, must equal the

expected HPR. Therefore,

D1

k= + g

P0

When everyone agrees on the same k (in equilibrium),

we can use the above formula to compute market

capitalization rate.

16

Constant dividend stream

Ifg = 0, then dividends do not grow and

stay the same forever. We have a

constant dividend stream a perpetuity.

The constant dividend stream assumption

is a special case of the constant growth

model with g = 0.

Implication: with constant dividend stream,

we continue to use the preceding

equations but set g to 0.

17

Applying the constant growth DDM (1)

A common stock pays an annual dividend

per share of $2.10. The risk-free rate is

7% and the risk premium for this stock is

4%. If the annual dividend is expected to

remain at $2.10 forever, what is the value

of the stock? (to two decimal places)

Verify that V0 = $19.09

18

Applying the constant growth DDM (2)

The risk-free rate of return is 10%, the

required rate of return on the market is

15%, and High-Flyer stock has a beta

coefficient of 1.5. If the dividend per share

expected during the coming year, D1, is

$2.50 and g = 5%, at what price should a

share sell?

Hint: use the CAPM to get the market

capitalization rate.

19

Applying the constant growth DDM (3)

BigOil Inc. just paid a dividend of $10 (i.e.,

D0 = 10.00). Its dividends are expected to

grow at a 4% annual rate forever. The

market capitalization rate is 15%. What is

the price of Big Oils common stock? (to 2

decimal places)

20

Applying the constant growth DDM (4)

The price of a stock in the market is $62.

You know that the firm has just paid a

dividend of $5 per share (i.e., D0 = 5). The

dividend growth rate is expected to be 6

percent forever. What is the market

capitalization rate for this stock (to 2

decimal places)?

21

Applying the constant growth DDM (5)

A firm is expected to pay a dividend of

$5.00 on its stock next year. The current

price of this stock is $40 and investors

require a return of 20%. The firms

dividends grow at a constant rate. What is

the constant dividend growth rate (g)?

use k = (D1/P0) + g

Verify that g = 7.5%

22

Applying the constant growth DDM (6)

In order to use the constant dividend growth

model to value a stock it must be true that:

a. The required rate of return is less than the expected

dividend growth rate.

b. The expected dividend growth rate is greater than zero.

c. The next dividend (D1) is expected to be greater than

$1.00.

d. The expected dividend growth rate is less than the

required rate of return.

Which statement is correct?

23

Stock prices &

investment/growth opportunities

How do we figure out dividend growth rate, g ?

Growth rate depends on:

1. Investment opportunities embodied in return

on equity, ROE

2. Reinvestment of earnings, represented by

earnings retention ratio, b.

Earnings retention ratio is also called the plowback

ratio.

Growth rate, g = ROE x b

24

Earnings retention ratio and

dividend payout ratio

Earnings retention rate

= reinvested earnings/ total earnings.

A related measure is the dividend payout

ratio.

Dividend payout ratio

= dividends paid/ total earnings

= 1 retention rate

25

Problem

Geoscience Corp. has a beta of 1.2 and its most

recent EPS is $10 per share. The company just paid

40% of its earnings in dividends. Geoscience Corp will

earn an ROE of 20% per year on all reinvested

earnings forever. The risk-free rate is 8% and the

expected return on the market portfolio is 15%.

a) What is the intrinsic value (V0) of a share of

Geosciences stock (to two decimal places)?

b) If the market price of a share is currently $100, and

you expect the market price to be equal to the intrinsic

value one year from now, what is your expected one-

year HPR on Geoscience Corp.s stock?

26

Earnings retention ratio

affects growth

policy policy

Earnings retention ratio, b b>0 b=0

earnings back into the business (b > 0), future earnings and

dividends will grow (i.e., g > 0). Otherwise, earnings and

dividends will not grow.

27

Is growth always beneficial?

Does having positive growth always

increase stock price?

No. It depends on the attractiveness of the

firms investment opportunities, ROE.

Compared to a no-growth policy,

If ROE > k, then retaining earnings (i.e., b > 0)

will increase stock price.

If ROE < k, then retaining earnings will

decrease stock price.

28

Consider two companies

Growth Dead Beat,

Prospects, Inc (DB)

Inc (GP)

No-growth earnings per share $5 $5

Market capitalization rate, k 12.5% 12.5%

29

Suppose both companies reinvest

60% of next years earnings

Growth Prospects, Dead Beat, Inc

Inc (GP) (DB)

Earnings retention ratio, b 0.6 0.6

Next years dividend per $2 $2

share,

D1 = (1 b) x 5

Dividend growth rate, g 9% 6%

= ROE x b

Constant dividend growth 2/(0.125 0.09) 2/(0.125 0.06)

model share price = 57.14 = 30.77

30

Compare GP and DB

Growth Dead Beat,

Prospects, Inc Inc (DB)

(GP)

ROE 15% 10%

Market capitalization rate, k 12.5% 12.5%

No-growth price per share (1) 40 40

Constant div. growth Price (2) 57.14 30.77

Present value of growth 17.14 -9.23

opportunities, PVGO = (2) (1)

31

Problems involving growth (1)

MF Corp. has an ROE of 16% and a

plowback ratio of 50%. If the coming

years earnings are expected to be $2

per share. The market capitalization rate

is 12%.

A. At what price will the stock sell today?

B. At what price do you expect MF shares

to sell for in 3 years?

32

Problems involving growth (2)

Even Better Products has come out with a new

and improved product. As a result, the firm

projects an ROE of 20%, and it will maintain a

retention ratio of 0.30. Its earnings in one year

will be $2 per share. Investors expect a 12%

rate of return on the stock.

a) Calculate the stock price.

b) What is the present value of growth

opportunities (PVGO)?

c) What would be the stock price and PVGO if the

firm reinvests only 20% of its earnings?

33

Multi-stage dividend growth 1

With this assumption, dividends grow at

different rates for different periods of time.

Eventually, dividends will grow at a

constant rate forever.

Time line is very useful for valuing this

type of stocks.

To value such stocks, also need the

constant growth formula.

Best way to learn is through an example.

34

Multi-stage dividend growth 2

ABC Co. is expected to pay dividends at the end of the

next three years of $2, $3, $3.50, respectively. After

three years, the dividend is expected to grow at 5%

constant annual rate forever. If the market capitalization

rate for this stock is 15%, what is the current stock price?

Dividends grow

$2.00 $3.00 $3.50

at 5% forever

35

What to do?

1. Place yourself at t = 3 and use the

constant growth formula to find PV of

dividend stream after year 3. Call this P3.

2. Find the PV of P3.

3. Find PV of dividends at t=1, t=2 and t=3.

4. Current stock price = sum of 2, 3 and 4.

36

Apply the method to

find ABCs stock price

P3 = (3.5 x (1.05))/(0.15 0.05) = 36.75

2 3 3.50 36.75

P0 = + 2 + 3

+ 3

1.15 (1.15) (1.15) (1.15)

2 3 3.50 + 36.75

= + 2 + 3

1.15 (1.15) (1.15)

= $30.47

37

Another type of

multi-stage growth problem

Malcolm Manufacturing, Inc. just paid a $2.00

annual dividend (that is, D0 = 2.00). Investors

believe that the firm will grow at 10% annually for

the next 2 years and 6% annually forever

thereafter. Assuming a required return of 15%,

what is the current price of the stock (to 2 decimal

places)?

Use timeline to see the problem better.

Verify that stock price = $25.29

38

Price-earnings (P/E) ratios

P/E ratio is the ratio of current price per

share (P0) to next years expected

earnings per share (EPS).

How do we use P/E ratio to value a stock?

1. Forecast next years EPS, E1.

2. Forecast P/E ratio, P0/E1.

3. Multiple P/E by EPS to get current

estimate of price.

(P0/E1) x E1 = P0

39

P/E ratio and

constant growth model

Ifa company has a constant dividend

growth rate and the market is in

equilibrium (i.e., V0=P0), then we have an

explicit formula for the P/E ratio!

P0 1 b

E1 k ( ROE b)

Recall that b = retention ratio, k = market capitalization rate.

40

P/E questions (1)

ABC Co. has an ROE of 25%, a CAPM

beta of 1.2 and a retention ratio of 40%.

The risk-free rate is 6% and the market

risk premium is 5%. What is ABCs P/E

ratio?

41

P/E questions (2)

Analog Electronic Corporation has an ROE =

9% and a beta of 1.25. It plans to maintain

indefinitely its traditional plowback ratio of 2/3.

The most recent earnings per share is $3 per

share. The expected market return is 14% and

the risk-free rate is 6%.

a) What is Analogs stock price?

b) Calculate the P/E (P0/E1) ratio.

c) Calculate the PVGO.

42

Free Cash Flow Valuation Approach

Dividend discount models dont work for

companies which do not pay dividends.

For non-dividend paying companies, we

can use free cash flow valuation approach.

There are two versions:

Free cash flow to the firm (FCFF)

Free cash flow to equity holders (FCFE)

43

Free Cash Flow to the Firm (FCFF) (1)

FCFF: cash flow that accrues from the firms

operations, net of investments in capital and net

working capital.

FCFF represent cash flows available to both

debt and equity holders.

FCFF = EBIT(1 tc) + Depreciation capital

expenditures increase in NWC

EBIT = earnings before interest and taxes

tc = corporate tax rate

NWC (net working capital) = current asset current

liability

44

Free Cash Flow to the Firm (FCFF) (2)

Capital expenditure includes:

1. acquiring fixed, and in some cases, intangible assets

2. repairing an existing asset so as to improve its useful

life

3. upgrading an existing asset if its results in a superior

fixture

4. preparing an asset to be used in business

5. restoring property or adapting it to a new or different

use

6. starting or acquiring a new business

45

Free Cash Flow to the Firm (FCFF) (3)

Find the PV of the firm by discounting the year-

by-year FCFF plus some estimate of terminal

value, PT.

T

FCFFt PT

Firm Value= (1 WACC )t (1 WACC )

t 1

FCFFT 1

where PT

WACC g

Market value of equity = Firm value market value of debt.

46

Free Cash Flow to Equity Holders (FCFE)

FCFE: Free cash flow available to equity holders.

FCFE = FCFF interest expense(1 tc) + increases in

net debt

Find the market value of equity by discounting the year-

by-year FCFE plus some estimate of terminal value, PT.

K E is the cost of equity.

T

FCFE PT

market value of equity

t 1 (1 k E ) t

(1 k E ) T

FCFET 1

where PT

kE g 47

Summary

1. Distinguish between the intrinsic value and price.

2. Calculate intrinsic value using dividend discount

models

Constant dividend growth model

Multistage dividend growth model

3. Discuss the use of the P/E ratio to value common

stock.

4. Calculate the P/E ratio for a constant growth firm.

5. Discuss the free cash flow valuation methods.

48

Practice 5

Chapter 13:

4,5,6,7, 9,10,11,14,15, 17,19, 21, 23

49

## Muito mais do que documentos

Descubra tudo o que o Scribd tem a oferecer, incluindo livros e audiolivros de grandes editoras.

Cancele quando quiser.