contemporary investments: chapter 14 chapter 14 fundamentals of common stock valuation what is...
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Contemporary Investments: Chapter 14
Chapter 14 FUNDAMENTALS OF COMMON
STOCK VALUATION
• What is intrinsic value (IV)?
• What is the dividend discount model (DDM)?
• What is the earnings model (EM)?
• How does an investor conduct fundamental analysis on a company stock?
Contemporary Investments: Chapter 14
FUNDAMENTALS OF COMMON STOCK VALUATION-Cont.
• How can an investor value a stock with nonconstant growth?
• How is the market-to-book ratio (MV/BV) used for investment purposes?
• What are the pros and cons of using the price/earnings multiple, or P/E ratio?
Contemporary Investments: Chapter 14
Intrinsic Value
• Definition of an intrinsic value– What affects intrinsic value– How to invest based on intrinsic value
• Undervalued
• Overvalued
Contemporary Investments: Chapter 14
Four intrinsic valuation models• Dividend Discount Model (DDM)
• Earnings Model (EM)
• P/E Ratio
• MV/BV Ratio
Contemporary Investments: Chapter 14
Dividend Discount Model (DDM)
• Develop the intrinsic value, Vs0
• Two implications
• The general Dividend Discount Model– An example: Lone Star Steakhouse
(STAR)
Contemporary Investments: Chapter 14
Trading rule for fundamental analysis
• Undervalued
• Overvalued
Contemporary Investments: Chapter 14
Earnings Model (EM)
• Lone Star Steakhouse: An Earnings Model example
• The no-growth example
• The constant-growth example
Contemporary Investments: Chapter 14
Implications for growth companies
• Discussion of the five implications
• Contrast growth company with a growth stock
Contemporary Investments: Chapter 14
Fundamental Analysis in Practice
• Estimate Growth, g– historical dividend trend growth rate
– historical EPS trend growth rate
– growth rate g = ROE x b
• Estimate the required rate of return, ERs
• Estimate DIV1
Contemporary Investments: Chapter 14
Figure 14.3 – Value Line Report for Lone Star Steakhouse (STAR)
Contemporary Investments: Chapter 14
Caveats for DDM
• DDM is very sensitive to changes in g
• The market risk premium, (ERM-RF) is difficult to determine
• ROE1 is a book value and is an average of many project returns
Contemporary Investments: Chapter 14
Nonconstant-Growth Model
• Value the nonconstant-growth phase via an example
• Value of the constant-growth phase• Intrinsic value of a two-phase
nonconstant growth stock• General formula for nonconstant-growth
model• Three-phase nonconstant-growth model• Estimating the nonconstant and constant
growth rates
Contemporary Investments: Chapter 14
Market-to-Book Ratio (MV/BV)
• Define Market-to-Book Ratio (MV/BV)
• Why it may discover undervalued stocks
• Beware of MV/BV
Contemporary Investments: Chapter 14
Price/Earnings (P/E) Ratio
• Define Price/Earnings (P/E) Ratio
• Interpret P/E ratios
• Determining value from P/E
• What about low P/Es?
• Implications for investors