Upload
deebutt
View
229
Download
0
Embed Size (px)
Citation preview
7/31/2019 Lecture 2(Ch7) - NCBA&E
1/60
Financial Management-2
Winter Semester 2011
NCBA&E
Instructor: Jamal Nasir Khan
7/31/2019 Lecture 2(Ch7) - NCBA&E
2/60
7/31/2019 Lecture 2(Ch7) - NCBA&E
3/60
7/31/2019 Lecture 2(Ch7) - NCBA&E
4/60
Equity Markets & Stock Valuation
Learning Objectives
Common Stock Valuation
Dividend Growth model
Zero Growth
Constant Growth
Multiple/Variable Growth
Components of Required Return
Features of Stocks
Stock Markets
7/31/2019 Lecture 2(Ch7) - NCBA&E
5/60
Capital Market Securities
Fixed Income (Bonds)
Treasuries
Agencies
Municipals
Corporate
Equities
Preferred Stock
Common Stock
7/31/2019 Lecture 2(Ch7) - NCBA&E
6/60
Stocks
It is an equity ownership in a corporation, initiallyissued to raise capital
Points to keep in mind (vs Bonds)
C/Fs are NOT known in advance
Life of stocks is forever no maturityDifficult to observe required rate of return for
discounting
7/31/2019 Lecture 2(Ch7) - NCBA&E
7/60
Stocks
How do we come up with the Price of a Stock?
PV of all future expected C/Fs?
Assumptions will be needed!
Assume a dividend the stock will pay.
Assume a selling price at the end of 1 year.
Come up with a required rate of return.
7/31/2019 Lecture 2(Ch7) - NCBA&E
8/60
Stocks Valuation
Assumptions will be needed!
Assume a dividend the stock will pay.
Assume a selling price at the end of 1 year.
Come up with a required rate of return.
Example: At the end of 1 year
Stock selling price is $70
Stock dividend will be $10
U need a 25% return
PV will be 80/(1.25) = $64 (u should pay today)
7/31/2019 Lecture 2(Ch7) - NCBA&E
9/60
Stocks Valuation
Example: For 1 year
Stock selling price is $70 (P1)Stock dividend will be $10 (D1)
U need a 25% return (R)
PV will be 80/(1.25) = $64 (Po) (u should pay today)
Therefore we can write:
Po = (D1+P1) / (1+R)
NOTE: coming up with a stock price @ end year is not easy!!
7/31/2019 Lecture 2(Ch7) - NCBA&E
10/60
Stocks Valuation
Example: For 1 year
P1 @ t1, would be found the same way byassuming the year 2 price & dividend:
P1 = (D2+P2) / (1+R)
Here then P1 really equals the P1 we used at Po.
Thus we can substitute:
7/31/2019 Lecture 2(Ch7) - NCBA&E
11/60
Stocks Valuation
Example: For 1 year
substituting P1 in Po equation:
Po = (D1+ (D2+P2)/1+R) / (1+R)
= D1/(1+R)^1 + D2/(1+R)^2 + P2/(1+R)^2
If u repeat this forever, the P2 ultimately has a PV of almost ZERO!!
7/31/2019 Lecture 2(Ch7) - NCBA&E
12/60
Stocks Valuation
Formula:
Po = E Dn / (1+R)^n
PV of all future dividends
as a general valuation framework.
Dividends to infinity are still a problem at this stage!
7/31/2019 Lecture 2(Ch7) - NCBA&E
13/60
Stocks Valuation
The problem of NO dividends.
This formula assumes the company will paysomething at some point in its life to itsshareholders.
A Corp where money goes in but nothingcomes out doesnt exist. Or shouldnt exist!
7/31/2019 Lecture 2(Ch7) - NCBA&E
14/60
Stocks Valuation
Special Cases. of dividends
Zero-growth:Here the dividend is constant, D1=D2=D
So, the value of the stock is a Perpetuity (ordinary),
Po = D/R same as PV = C/r
7/31/2019 Lecture 2(Ch7) - NCBA&E
15/60
Stocks Valuation
Example zero-growth
Suppose a company pays Rs. 10 dividend always.
If this policy is forever,
Whats the stock price if the required return is20%?
7/31/2019 Lecture 2(Ch7) - NCBA&E
16/60
Stocks Valuation
Example zero-growth
Suppose a company pays Rs. 10 dividend always.
If this policy is forever,
Whats the stock price if the required return is20%?
Po = 10 / 0.2 = Rs 50 per share
7/31/2019 Lecture 2(Ch7) - NCBA&E
17/60
Stocks Valuation
Special Cases. of dividends
Constant Growth Model:
Suppose the dividend grows at a constant rate g.
If dividend just paid is Do, then the next D1 is:
D1 = Do x (1+g)
& for 2 periods is:
D2 = Do x (1+g)^2 (FV formula)
D2 = (Do x (1+g)) x (1+g)
7/31/2019 Lecture 2(Ch7) - NCBA&E
18/60
Stocks Valuation
Growing Perpetuity:
An asset where the C/Fs grow at a constant rate forever.
Putting these dividends in the formula:
Po = Do(1+g)^1/(1+R)^1 + Do(1+g)^2/(1+R)^2
we can write this simply as:
Po = Do x (1+g) / R-g OR D1 / R - g
7/31/2019 Lecture 2(Ch7) - NCBA&E
19/60
Stocks Valuation
Dividend Growth Model:
Determines the Stock Price with constant growthdividends.
Po = Do x (1+g) / R-g
OR
D1 / R - g (g
7/31/2019 Lecture 2(Ch7) - NCBA&E
20/60
Example:
Suppose Do = 2.30, R=13%, g=5%.
Whats the price per share?
Stocks Valuation
7/31/2019 Lecture 2(Ch7) - NCBA&E
21/60
Example:
Suppose Do = 2.30, R=13%, g=5%.
Whats the price per share?
D1 / R - g (g
7/31/2019 Lecture 2(Ch7) - NCBA&E
22/60
Stocks Valuation
Note:
You can use this to find the stock price at anypoint in time!
Just find the D for that year,
grow it at (1+g)
& then divide by R-g
7/31/2019 Lecture 2(Ch7) - NCBA&E
23/60
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
Whats the price per share in 5 years?
D6 / R - g (g
7/31/2019 Lecture 2(Ch7) - NCBA&E
24/60
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
Whats the price per share in 5 years?
Formula is:
Dt+1 / R - g (g
7/31/2019 Lecture 2(Ch7) - NCBA&E
25/60
Stocks Valuation
Example:
Suppose Do = 2.30, R=13%, g=5%.
Whats the price per share in 5 years?
D6 / R - g (g
7/31/2019 Lecture 2(Ch7) - NCBA&E
26/60
Example:
Suppose Company Ts next dividend will be $4.Required return is 16%.
Dividend increases by 6% every year.
Whats the price per share today?
& in 4 years?
Stocks Valuation
7/31/2019 Lecture 2(Ch7) - NCBA&E
27/60
Stocks Valuation
Example:
Suppose next dividend will be $4. Required return is 16%. Dividendincreases by 6% every year.
D1 = 4 , R=16%, g=6%. (since D1 is given, dont need to grow by g)
Whats the price per share today?
Po = D1 / R - g (g
7/31/2019 Lecture 2(Ch7) - NCBA&E
28/60
Stocks Valuation
Notice here:
P4 = Po (1+g)^4
50.50 = 40 x (1.06)^4
So, Stock price grows at the same constant rate as the Dividend!
P4 is simply D5/(R-g)
7/31/2019 Lecture 2(Ch7) - NCBA&E
29/60
Components of Required Return
Lets break down the R, discount rate which weused in the Dividend Growth Model or DDM
Po = D1 / (R-g)if we rearrange to solve for R.
then
R-g = D1/PoR = D1/ Po + g
7/31/2019 Lecture 2(Ch7) - NCBA&E
30/60
Components of Required Return
R = D1/ Po + g
This means TR has 2 components:
D1/Po = Dividend Yield
g = same rate as the increase in stock price
= Capital gains yield
7/31/2019 Lecture 2(Ch7) - NCBA&E
31/60
Components of Required Return
EXAMPLE
R = D1/ Po + g
If a stock is selling for $20 per share. Next
dividend will be $1 per share. Dividend willgrow by 10% per year forever.
What is the return on this stock?
7/31/2019 Lecture 2(Ch7) - NCBA&E
32/60
Components of Required Return
EXAMPLE
R = D1/ Po + g
If a stock is selling for $20 per share. Next dividend willbe $1 per share. Dividend will grow by 10% per year
forever.What is the return on this stock?
R = Div yield + Cap gains yield
= 1/20 + 10%
= 5% + 10% = 15%
7/31/2019 Lecture 2(Ch7) - NCBA&E
33/60
Stocks Valuation
Multiple Growth Model
Company grows at a certain high rate first, then slows down
to grow at a constant sustainable rate.
illustrate concept
7/31/2019 Lecture 2(Ch7) - NCBA&E
34/60
Stocks Valuation
Multiple Growth Model
Company grows at a certain high rate first, thenslows down to grow at a constant sustainable rate.
Value = PV of dividends + PV of terminal price
= E Do(1+g)^t / (1+k) + Dn(1+g)/(k-g).1/1+k^n
illustrate concept
7/31/2019 Lecture 2(Ch7) - NCBA&E
35/60
Stocks Valuation
Intrinsic Value & Market Price
If IV > Mkt Price = under/over-valued?
IV < Mkt Px = under/over valued?
7/31/2019 Lecture 2(Ch7) - NCBA&E
36/60
Stocks ValuationMultiple growth
Example:
MCB is expanding and is expected to grow at a rate of 20% per year forthe next three years. Current dividend is Rs. 2 per share. After thisrapid growth, the company is likely to slow down to a normal growth of7% for the foreseeable future. Required return on this stock is 22%.
D1 = 2*(1.20) = 2.40 , R=22%, G1= 20%, g=7%.
Whats the price per share today?
Solution in Excel MCB
http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/http://stock%20intrinsic%20value%281%29.xls/7/31/2019 Lecture 2(Ch7) - NCBA&E
37/60
Relative Valuation Techniques
Making Valuations through comparisons
P/E = Price to Earnings ratio
so if comparable stocks are trading at x15.
& Earnings for a stock are equal to: $3
What should be the stock price? 45Forward P/E = Po/E1
7/31/2019 Lecture 2(Ch7) - NCBA&E
38/60
Relative Valuation Techniques
Making Valuations through comparisons
P/E = Payback period!
P/E = 15, EPS= $3, Px=45
So P/E of 15= 15 years payback!
Also:
1/15 = 6.66% yield indicating low pay-off for investors!
7/31/2019 Lecture 2(Ch7) - NCBA&E
39/60
Relative Valuation Techniques
Making Valuations through comparisons
P/BV = Price to Book Value (S.Equity) ratio
so if comparable stocks are trading at x10.
& BV for a stock is equal to: $5
What should be the stock price?50
7/31/2019 Lecture 2(Ch7) - NCBA&E
40/60
Relative Valuation Techniques
Making Valuations through comparisons
P/S = Price to Sales ratio
so if comparable stocks are trading at x1.
& Sales for a stock is equal to: $5
What should be the stock price?5
7/31/2019 Lecture 2(Ch7) - NCBA&E
41/60
Cash Flows between the Firm and the Financial Markets
Total Value of
Firms Assets
Total Value of the Firmto Investors in
the Financial Markets
B. Firminvests inassets
CurrentAssetsFixedAssets
C. Cash flow fromfirms assets
D. Government
E. Retained cash flows
A. Firm issues securities
F. Dividends and
debt payments
FinancialMarkets
Short-term debtLong-term debtEquity shares
7/31/2019 Lecture 2(Ch7) - NCBA&E
42/60
Major Types of Financial Assets
ORGANIZATION
DIRECT INVESTING
Non-Marketablesecurities
Money Markets
Capital Markets
Derivatives Markets
INDIRECT INVESTING
Investment Companies
Mutual Funds Stock, Bond Funds
Unit Investment Trusts
Wh t M j T f Fi i l A t ?
7/31/2019 Lecture 2(Ch7) - NCBA&E
43/60
What are Major Types of Financial Assets?
Direct Investing
Capital Market Securities
Fixed Income (Bonds)
Treasuries
Agencies
Municipals
Corporate
Equities
Preferred Stock Common Stock
Wh M j T f Fi i l A ?
7/31/2019 Lecture 2(Ch7) - NCBA&E
44/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
Equity Security:
Preferred Stock:
Common Stock:
Voting Rights:
What are Major Types of Financial Assets?
7/31/2019 Lecture 2(Ch7) - NCBA&E
45/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
Equity Security:Represents an ownership interest in a corporation. Afterpayment of all obligations to fixed-income claims, provides residual claim.
Preferred Stock:Hybrid security: Pays dividends known in advance & fallsb/w Bonds & common stocks. However, dividends may be deferred.
Common Stock: Represents ownership interest of corporations or Equity ofstock holders (also called Equity securities)
Example: 100 shares of common stock represents 100/n% ownership interest in thecorp (n=outstanding shares).
Voting Rights: Gives C.S. Holders legal control of the Corp. Elect the boardof Directors as their reps. To run the corp.
Wh t M j T f Fi i l A t ?
7/31/2019 Lecture 2(Ch7) - NCBA&E
46/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
Common Stock Characteristics
Par Value:
Book Value:
Limited Liability:
Market Value (Cap):
Dividends:
Dividend Yield:
Payout Ratio:
Retention Ratio:
What are Major Types of Financial Assets?
7/31/2019 Lecture 2(Ch7) - NCBA&E
47/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
Common Stock Characteristics Par Value:Not a significant economic variable. Any number can be chosen. New
stock usually sells for more than PAR.
Book Value:The accounting value of the equity as shown on the Balance Sheet.Sum of Stock Outstanding, Capital in excess of Par & Retained Earnings.
Limited Liability:Investors cannot lose more than their investment. Creditorshave access only to the assets of the corp.
Market Value: Market Capitalization: Price of Stock x Shares outstanding
Dividends: Cash Payments declared & paid to stockholders
Dividend Yield: 12 month dividend / current stock price
Payout Ratio: Dividends / Earnings (indicates % of a firms earnings paid out)
Retention Ratio: 1 Payout Ratio (% of firms earnings retained)
What are Major Types of Financial Assets?
7/31/2019 Lecture 2(Ch7) - NCBA&E
48/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
Stock Example
Coca-Colas 2002 EPS = $1.23. Paid annual dividend DPS of
$0.8. If price of KO is $45, calculate the following. DY?
Payout ratio?
If the company reported $11.8 Billion in Stockholder Equity &
the outstanding shares are 2.478 Billion, whats the BVS?
What are Major Types of Financial Assets?
7/31/2019 Lecture 2(Ch7) - NCBA&E
49/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
Stock Example
Coca-Colas 2002 EPS = $1.23. Paid annual dividend DPS of$0.8. If price of KO is $45, calculate the following.
Dividend Yield: 0.8/45 = 1.8%
Payout Ratio: 0.8/1.23 = 65%
If the company reported $11.8 Billion in Stockholder Equity &the outstanding shares are 2.478 Billion, whats the BVS?
BVS = 11.8 / 2.478 = $4.76
What are Major Types of Financial Assets?
7/31/2019 Lecture 2(Ch7) - NCBA&E
50/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
More Common Stock Characteristics
Stock Dividend:
Stock Split:
P/E Ratio:
What are Major Types of Financial Assets?
7/31/2019 Lecture 2(Ch7) - NCBA&E
51/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
More Common Stock Characteristics
Stock Dividend:Payment of a dividend in the form of stock (instead of cash)
Stock Split:Issuance of stock in proportion to shares outstanding
P/E Ratio: Stock Price/ EPS (what investors are paying per dollar of earnings)
Example: Price of X = $25, EPS = 1.5
P/E = 25/1.5 = ?
What are Major Types of Financial Assets?
7/31/2019 Lecture 2(Ch7) - NCBA&E
52/60
What are Major Types of Financial Assets?
Direct InvestingEquity Securities
More Common Stock Characteristics
Stock Dividend:Payment of a dividend in the form of stock (instead of cash)
Stock Split:Issuance of stock in proportion to shares outstanding
P/E Ratio: Stock Price/ EPS (what investors are paying per dollar of earnings)
Example: Price of X = $25, EPS = 1.5
P/E = 25/1.5 = 16.6
7/31/2019 Lecture 2(Ch7) - NCBA&E
53/60
Financial Markets?
US Securities Markets for Equities
Dow Jones Industrial Average
Standard & Poors (S&P 500)
Nasdaq
Pakistani Securities Markets for Equities
KSE (Karachi Stock Exchange)
7/31/2019 Lecture 2(Ch7) - NCBA&E
54/60
Financial Markets?
US Securities Markets for Equities
Dow Jones Industrial Average
30 Blue chip stocks stock price weighted average
Standard & Poors (S&P 500)
500 stock composite
Nasdaq
100 Large cap companies
The Dow Jones Industrial Average consists of the following 30companies:
3M Co (NYSE: MMM) (conglomerates "manufacturing") H ll I i l I S HON
7/31/2019 Lecture 2(Ch7) - NCBA&E
55/60
3M Co. (NYSE: MMM) (conglomerates, manufacturing ) ALCOA Inc. (NYSE:AA) (aluminium) Altria Group, Inc. (NYSE: MO) (tobacco, foods) American International Group, Inc. (NYSE:AIG) (property
& casualty insurance) American Express Co. (NYSE:AXP) (credit services) AT&T Inc. (NYSE: T) (telecoms) Boeing Co., The (NYSE: BA) (aerospace/defense) Caterpillar, Inc. (NYSE: CAT) (farm & construction
equipment) Citigroup, Inc. (NYSE: C) (money center banks) Coca-Cola Co. (NYSE: KO) (beverages) E.I. du Pont de Nemours & Co. (NYSE: DD) (chemicals) Exxon Mobil Corp. (NYSE:XOM) (major integrated oil & gas) General Electric Co. (NYSE: GE) (conglomerates, media)
General Motors Corporation (NYSE: GM) (automanufacturers) Hewlett-Packard Co. (NYSE: HPQ) (diversified computer
systems) Home Depot, Inc. (NYSE: HD) (home improvement stores)
Honeywell International, Inc. (NYSE: HON)(conglomerates)
Intel Corp. (NYSE: INTC) (semiconductors)
International Business Machines Corp. (NYSE: IBM)(diversified computer systems)
JPMorgan Chase and Co. (NYSE: JPM) (money centebanks)
Johnson & Johnson Inc. (NYSE: JNJ) (consumer andhealth care products conglomerate)
McDonald's Corp. (NYSE: MCD) (restaurant franchise
Merck & Co., Inc. (NYSE: MRK) (drug manufacturers)
Microsoft Corp. (NYSE: MSFT) (software)
Pfizer, Inc. (NYSE: PFE) (drug manufacturers)
Procter & Gamble Co. (NYSE: PG) (consumer goods)
United Technologies Corp. (NYSE: UTX) (conglomera
Verizon Communications (NYSE: VZ) (telecoms)
Wal-Mart Stores, Inc. (NYSE: WMT) (discount, varietystores)
Walt Disney Co., The (NYSE: DIS) (entertainment)
7/31/2019 Lecture 2(Ch7) - NCBA&E
56/60
T f O d
7/31/2019 Lecture 2(Ch7) - NCBA&E
57/60
Types of Orders
Market Order Limit Order
Stock Order
Clearing Procedures (T+3)
7/31/2019 Lecture 2(Ch7) - NCBA&E
58/60
Types of Orders
Market OrderBest price on the floor ENSURES EXECUTION NOT PX
Limit Orderspecified or better price ENSURES PX NOT EXECUTION
Stop Order
Automatic execution at specified price BUY STOP PROTECTS PROFITS
SELL STOPS PROTECT LOSSES
Clearing Procedures (T+3)Trade Day plus 3 business days
7/31/2019 Lecture 2(Ch7) - NCBA&E
59/60
Short Sales
Being Long Being Short
Short Sale
Short Interest Ratio
7/31/2019 Lecture 2(Ch7) - NCBA&E
60/60