chapter 12 equity valuation. mcgraw-hill/irwin © 2004 the mcgraw-hill companies, inc., all rights...
TRANSCRIPT
Chapter 12
Equity Valuation
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Fundamental Stock Analysis: Models of Equity
Valuation
• Basic Types of Models• Balance Sheet Models• Dividend Discount Models• Price/Earning Ratios
• Estimating Growth Rates and Opportunities
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Intrinsic Value and Market Price
• Intrinsic Value• Self assigned Value• Variety of models are used for estimation
• Market Price• Consensus value of all potential traders
• Trading Signal• IV > MP Buy• IV < MP Sell or Short Sell• IV = MP Hold or Fairly Priced
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Dividend Discount Models:General Model
VDk
ot
tt
( )11
• V0 = Value of Stock• Dt = Dividend• k = required return
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No Growth Model
VD
ko
• Stocks that have earnings and dividends that are expected to remain constant
• Preferred Stock
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
No Growth Model: Example
E1 = D1 = $5.00
k = .15
V0 = $5.00 / .15 = $33.33
VD
ko
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Constant Growth Model
VoD g
k g
o
( )1
• g = constant perpetual growth rate
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Constant Growth Model: Example
VoD g
k g
o
( )1
E1 = $5.00b = 40% k = 15%
(1-b) = 60% D1 = $3.00 g = 8%
V0 = 3.00 / (.15 - .08) = $42.86
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Estimating Dividend Growth Rates
g ROE b
• g = growth rate in dividends• ROE = Return on Equity for the firm• b = plowback or retention percentage rate
• (1- dividend payout percentage rate)
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Shifting Growth Rate Model
V Dg
k
D g
k g ko o
t
tt
TT
T
( )
( )
( )
( )( )
1
1
1
1
1
1
2
2
• g1 = first growth rate
• g2 = second growth rate
• T = number of periods of growth at g1
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Shifting Growth Rate Model: Example
D0 = $2.00 g1 = 20% g2 = 5%
k = 15% T = 3 D1 = 2.40
D2 = 2.88 D3 = 3.46 D4 = 3.63
V0 = D1/(1.15) + D2/(1.15)2 + D3/(1.15)3 +
D4 / (.15 - .05) ( (1.15)3
V0 = 2.09 + 2.18 + 2.27 + 23.86 = $30.40
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Specified Holding Period Model
01
12
2
1 1 1V D
kDk
D Pk
N NN
( ) ( ) ( )...
• PN = the expected sales price for the stock at time N
• N = the specified number of years the stock is expected to be held
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Partitioning Value: Growth and No Growth Components
VE
kPVGO
PVGOD g
k g
E
k
o
o
1
11( )
( )• PVGO = Present Value of Growth
Opportunities• E1 = Earnings Per Share for period 1
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Partitioning Value: Example
• ROE = 20% d = 60% b = 40%
• E1 = $5.00 D1 = $3.00 k = 15%
• g = .20 x .40 = .08 or 8%
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
V
NGV
PVGO
o
o
3
15 0886
5
1533
86 33 52
(. . )$42.
.$33.
$42. $33. $9.
Partitioning Value: Example
VVoo = value with growth = value with growth
NGVNGVoo = no growth component value = no growth component value
PVGO = Present Value of Growth OpportunitiesPVGO = Present Value of Growth Opportunities
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Price Earnings Ratios
• P/E Ratios are a function of two factors• Required Rates of Return (k)• Expected growth in Dividends
• Uses• Relative valuation• Extensive Use in industry
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
P/E Ratio: No expected growth
PE
kP
E k
01
0
1
1
• E1 - expected earnings for next year
• E1 is equal to D1 under no growth
• k - required rate of return
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
P/E Ratio with Constant Growth
PD
k g
E b
k b ROE
P
E
b
k b ROE
01 1
0
1
1
1
( )
( )
( )
• b = retention ration• ROE = Return on Equity
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Numerical Example: No Growth
E0 = $2.50 g = 0 k = 12.5%
P0 = D/k = $2.50/.125 = $20.00
PE = 1/k = 1/.125 = 8
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Numerical Example with Growth
b = 60% ROE = 15% (1-b) = 40%
E1 = $2.50 (1 + (.6)(.15)) = $2.73
D1 = $2.73 (1-.6) = $1.09
k = 12.5% g = 9%
P0 = 1.09/(.125-.09) = $31.14
PE = 31.14/2.73 = 11.4
PE = (1 - .60) / (.125 - .09) = 11.4
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Pitfalls in Using PE Ratios
• Flexibility in reporting makes choice of earnings difficult
• Pro forma earnings may give a better measure of operating earnings
• Problem of too much flexibility
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Other Valuation Ratios & Approaches
• Price-to-book• Price-to-cash flow• Price-to-sales• Present Value of Free Cash Flow