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1、,CHAPTER 9Stocks and Their Valuation,Features of common stockDetermining common stock valuesEfficient marketsPreferred stock,Represents ownership.Ownership implies control.Stockholders elect directors.Directors elect management.Managements goal:Maximize stock price.,Facts about Common Stock,Social/E
2、thical Question,Should management be equally concerned about employees,customers,suppliers,“the public,”or just the stockholders?In enterprise economy,work for stockholders subject to constraints(environmental,fair hiring,etc.)and competition.,Classified stock has special provisions.Could classify e
3、xisting stock as founders shares,with voting rights but dividend restrictions.New shares might be called“Class A”shares,with voting restrictions but full dividend rights.,Whats classified stock?How might classified stock be used?,When is a stock sale an initial public offering(IPO)?,A firm“goes publ
4、ic”through an IPO when the stock is first offered to the public.,Average Initial Returns on IPOs in Various Countries,Malaysia,100%75%50%25%,Brazil,Portugal,Japan,Sweden,United States,Canada,Dividend growth modelFree cash flow methodUsing the multiples of comparable firms,Different Approaches for Va
5、luing Common Stock,One whose dividends are expected togrow forever at a constant rate,g.,Stock Value=PV of Dividends,What is a constant growth stock?,For a Constant Growth Stock,D1=D0(1+g)1D2=D0(1+g)2Dt=Dt(1+g)t,P0=.,If g is constant,then:,D0(1+g)ks-g,D1ks-g,$,0.25,Years(t),0,What happens if g ks?,I
6、f ks g and(2)g is expected to be constant forever.,Assume beta=1.2,kRF=7%,and kM=12%.What is the required rate of return on the firms stock?,ks=kRF+(kM kRF)bFirm=7%+(12%7%)(1.2)=13%.,Use the SML to calculate ks:,D0 was$2.00 and g is a constant 6%.Find the expected dividends for the next 3 years,and
7、their PVs.ks=13%.,0,1,2.247,2,2.382,3,g=6%,1.8761,1.7599,D0=2.00,1.6509,13%,2.12,=,Whats the stocks market value?D0=2.00,ks=13%,g=6%.,Constant growth model:,P0=,D1,ks g 0.13 0.06,$2.12,$2.12,0.07,$30.29.,D1 will have been paid,so expected dividends are D2,D3,D4 and so on.Thus,Could also find P1 as f
8、ollows:,ks g 0.13 0.06,P1=,What is the stocks market value one year from now,P1?,D2,$2.247,=$32.10.,P1=P0(1.06)=$32.10.,Find the expected dividend yield,capital gains yield,and total return during the first year.,Dividend yld=,Cap gains yld=,Total return=7.0%+6.0%=13.0%.,D1,P0,P1 P0,P0,$30.29,$2.12,
9、7.0%.,$32.10$30.29,$30.29,=6.0%.,Rearrange model to rate of return form:,Then,ks=$2.12/$30.29+0.06=0.07+0.06=13%.,P0=$15.38.,What would P0 be if g=0?,The dividend stream would be a perpetuity.,2.00,2.00,2.00,0,1,2,3,13%,.,PMTk,$2.000.13,Can no longer use constant growth model.However,growth becomes
10、constant after 3 years.,If we have supernormal growth of 30%for 3 years,then a long-run constant g=6%,what is P0?k is still 13%.,Nonconstant growth followed by constantgrowth:,0,2.301,2.647,3.045,46.116,1,2,3,4,ks=13%,54.109=P0,g=30%,g=30%,g=30%,g=6%,D0=2.00 2.600 3.380 4.394 4.658,$,.,.,.,$66.54,P,
11、3,4.658,13,0,06,=,-,=,0,.,What is the expected dividend yield and capital gains yield at t=0?At t=4?,Div.yield0=4.81%.,Cap.gain0=13.00%4.81%=8.19%.,$2.60$54.11,During nonconstant growth,D/P and capital gains yield are not constant,and capital gains yield is less than g.After t=3,g=constant=6%=capita
12、l gains yield;k=13%;so D/P=13%6%=7%.,25.72,Suppose g=0 for t=1 to 3,and then g is a constant 6%.What is P0?,0,1.77,1.57,1.39,20.99,1,2,3,4,ks=13%,g=0%,g=0%,g=0%,g=6%,2.00 2.00 2.00 2.00 2.12,.,$,P,3,2.12,0,07,30.29.,=,=,.,t=3:Now have constant growth with g=capital gains yield=6%and D/P=7%.,$2.00$25
13、.72,What is D/P and capital gains yield at t=0 and at t=3?,t=0:,D1,P0,=7.78%.,CGY=13%7.78%=5.22%.,If g=-6%,would anyone buy the stock?If so,at what price?,Firm still has earnings and still paysdividends,so P0 0:,(,),$,P,D,k,g,D,g,k,g,s,s,0,1,0,1,=,-,=,+,-,$2.00(0.94)$1.880.13(-0.06)0.19,=$9.89.,What
14、 is the annual D/P and capital gains yield?,Capital gains yield=g=-6.0%,Dividend yield=13.0%(-6.0%)=19%.D/P and cap.gains yield are constant,with high dividend yield(19%)offsettingnegative capital gains yield.,Free Cash Flow Method,The free cash flow method suggests that the value of the entire firm
15、 equals the present value of the firms free cash flows(calculated on an after-tax basis).Recall that the free cash flow in any given year can be calculated as:NOPAT Net capital investment.,Once the value of the firm is estimated,an estimate of the stock price can be found as follows:MV of common sto
16、ck(market capitalization)=MV of firm MV of debt and preferred stock.P=MV of common stock/#of shares.,Using the Free Cash Flow Method,Free cash flow method is often preferred to the dividend growth model-particularly for the large number of companies that dont pay a dividend,or for whom it is hard to
17、 forecast dividends.,Issues Regarding the Free Cash Flow Method,(More.),Similar to the dividend growth model,the free cash flow method generally assumes that at some point in time,the growth rate in free cash flow will become constant.Terminal value represents the value of the firm at the point in w
18、hich growth becomes constant.,FCF Method Issues Continued,416.942,FCF estimates for the next 3 years are-$5,$10,and$20 million,after which the FCF is expected to grow at 6%.The overall firm cost of capital is 10%.,0,-4.545,8.264,15.026,398.197,1,2,3,4,k=10%,g=6%,-5 10 2021.20,21.200.04,.,*TV3 repres
19、ents the terminal value of the firm,at t=3.,530=*TV3,If the firm has$40 million in debt and has 10 million shares of stock,what is the price per share?,Value of equity=Total value Value of debt=$416.94$40=$376.94 million.,Price per share=Value of equity/#of shares=$376.94/10=$37.69.,Analysts often u
20、se the following multiples to value stocks:P/EP/CFP/SalesP/CustomerExample:Based on comparable firms,estimate the appropriate P/E.Multiply this by expected earnings to back out an estimate of the stock price.,Using the Multiples of Comparable Firms to Estimate Stock Price,In equilibrium,stock prices
21、 are stable.There is no general tendency for people to buy versus to sell.In equilibrium,expected returns mustequal required returns:,What is market equilibrium?,ks=D1/P0+g=ks=kRF+(kM kRF)b.,ks=D1/P0+g=ks=kRF+(kM kRF)b.,Expected returns are obtained by estimating dividends and expected capital gains
22、(which can be found using any of the three common stock valuation approaches).Required returns are obtained from the CAPM.,How is equilibrium established?,If ks=+g ks,thenP0 is“too low”(a bargain).Buy orders sell orders;P0 bid up;D1/P0 falls untilD1/P0+g=ks=ks.,D1P0,Why do stock prices change?,1.ki
23、could change:ki=kRF+(kM kRF)bi.kRF=k*+IP.2.g could change due to economic or firm situation.,P0=,D1ki g,Whats the Efficient Market Hypothesis?,EMH:Securities are normally in equilibrium and are“fairly priced.”One cannot“beat the market”except through good luck or better information.,1.Weak-form EMH:
24、Cant profit by looking at past trends.A recent decline is no reason to think stocks will go up(or down)in the future.Evidence supports weak-form EMH,but“technical analysis”is still used.,2.Semistrong-form EMH:All publicly available information is reflected in stock prices,so doesnt pay to pore over
25、annual reports looking for undervalued stocks.Largely true,but superior analysts can still profit by finding and using new information.,3.Strong-form EMH:All information,even inside information,is embedded in stock prices.Not true-insiders can gain by trading on the basis of insider information,but
26、thats illegal.,Markets are generally efficient because:,1.15,000 or so trained analysts;MBAs,CFAs,Technical PhDs.2.Work for firms like Merrill,Morgan,Prudential,which have a lot of money.3.Have similar access to data.4.Thus,news is reflected in P0 almost instantaneously.,Preferred Stock,Hybrid secur
27、ity.Similar to bonds in that preferred stockholders receive a fixed dividend that must be paid before dividends can be paid on common stock.However,unlike interest payments on bonds,companies can omit dividend payments on preferred stock without fear of pushing the firm into bankruptcy.,Whats the expected return of preferred stock with Vp=$50 and annual dividend=$5?,
