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Slide 2 Slide 3 Slide 4 Slide 5 Fundamental Analysis looks at financials, product, mgt., history, etc. PE ratio Price / E.P.S. Zero-Growth Dividend (preferred stock) Constant Growth Dividend (DCF) Nonconstant Growth Slide 6 Technical Analysis uses charts to predict future prices Slide 7 Industry Average PE X Companys EPS If company EPS = $2.20 and industry average PE = 20, stock should sell around $_____. Factors affected a companys PE include: Risk Expected future growth Management Dividends Slide 8 Preferred has preference in claims to assets and dividends must be paid before common. Preferred dividends fixed Common dividends fluctuate Preferred usually have no voting rights Slide 9 Slide 10 P 0 = Value of Preferred Stock = PV of ALL dividends discounted at investors Required Rate of Return 52 WeeksYldVol Net HiLoStockSymDiv%PE100sHiLoCloseChg s4229QuakerOatsOAT1.143.3245067353434- s3625RJR NabiscoRN.08p...1262632928 5 / 8 28 7 / 8 - 23 7 / 8 20RJR Nab pfB2.319.7...9662423 5 / 8 23... 75RJR Nab pfC.609.4...2248666 3 / 8 - 1 / 8 0 1 2 3 P 0 =23.75D 1 =2.31D 2 =2.31D 3 =2.31D =2.31 23 7 / 8 20RJR Nab pfB2.319.7...9662423 5 / 8 23... Slide 11 P 0 = + + + 2.31 (1+ r p ) 2.31 (1+ r p ) 2 2.31 (1+ rk p ) 3 52 WeeksYldVol Net HiLoStockSymDiv%PE100sHiLoCloseChg s4229QuakerOatsOAT1.143.3245067353434- s3625RJR NabiscoRN.08p...1262632928 5 / 8 28 7 / 8 - 23 7 / 8 20RJR Nab pfB2.319.7...9662423 5 / 8 23... 75RJR Nab pfC.609.4...2248666 3 / 8 - 1 / 8 0 1 2 3 P 0 =23.75D 1 =2.31D 2 =2.31D 3 =2.31D =2.31 23 7 / 8 20RJR Nab pfB2.319.7...9662423 5 / 8 23... If an investor expects a 10% return, how much are they willing to pay for the stock? Slide 12 P 0 = D R = 2.31 10% = $23.10 P 0 = + + + 2.31 (1+ r p ) 2.31 (1+ r p ) 2 2.31 (1+ rk p ) 3 52 WeeksYldVol Net HiLoStockSymDiv%PE100sHiLoCloseChg s4229QuakerOatsOAT1.143.3245067353434- s3625RJR NabiscoRN.08p...1262632928 5 / 8 28 7 / 8 - 23 7 / 8 20RJR Nab pfB2.319.7...9662423 5 / 8 23... 75RJR Nab pfC.609.4...2248666 3 / 8 - 1 / 8 0 1 2 3 P 0 =23.75D 1 =2.31D 2 =2.31D 3 =2.31D =2.31 23 7 / 8 20RJR Nab pfB2.319.7...9662423 5 / 8 23... Zero-Growth Div. Model Slide 13 P 0 = PV of ALL expected dividends discounted at investors Required Rate of Return Investors do not know the values of D 1, D 2,...., D N. The future dividends must be estimated. D1D1 D2D2 D3D3 P0P0 D 0 1 2 3 P 0 = + + + D 1 (1+ r s ) D 2 (1+ r s ) 2 D 3 (1+ r s ) 3 Slide 14 Assume that dividends grow at a constant rate (g). D 1 =D 0 (1+g) D0D0 D 2 =D 0 (1+g) 2 D 3 =D 0 (1+g) 3 D =D 0 (1+g) 0 1 2 3 Slide 15 Requires r > g Reduces to: P 0 = + + + + D 0 (1+ g) (1+ r s ) D 0 (1+ g) 2 (1+ r s ) 2 D 0 (1+ g) 3 (1+ r s ) 3 P 0 = = D 0 (1+g) r g D 1 r g D 1 =D 0 (1+g) D0D0 D 2 =D 0 (1+g) 2 D 3 =D 0 (1+g) 3 D =D 0 (1+g) 0 1 2 3 Slide 16 Slide 17 Gordon Growth Company is expected to pay a dividend of $4 next period and dividends are expected to grow at 6% per year. The required return is 16%. What is the current price? Slide 18 What is the price expected to be in year 4? Slide 19 Used with companies that have very high growth rates. Calculate the PV of cash flows or dividends for the high growth period. Solve for the PV of cash flows during the constant growth period that are a perpetuity. The sum of these two is the stock price. Slide 20 9900010203040506070809101112Sales.2M6M86M440M1.4B3B6B10B16B21B23B29B37B50B Net Income -6M-15M7M100M105M 400 M 1.4 B 3B4.2B4.2B6.5B8.5B9.7B 10.7 B Slide 21 Can no longer only use constant growth model. However, growth becomes constant after 3 years. Slide 22 Supernormal growth followed by constant growth: 01234 r=13% = P 0 g = 30% g = 6% D 0 = 2.00 2.603.38 4.39 4.66 ^ Slide 23 Supernormal growth followed by constant growth: 01234 r =13% = P 0 g = 30% g = 6% D 0 = 2.00 2.603.38 4.39 4.66 ^ Slide 24 Supernormal growth followed by constant growth: 0 2.30 2.65 3.05 46.11 1234 r s =13% 54.11 = P 0 g = 30% g = 6% D 0 = 2.00 2.603.38 4.39 4.66 ^ Do not add in D 0 Slide 25 01234 r s =13% g = 0% g = 6% 2.00 2.00 2.00 2.12. P 3... Slide 26 01234 r s =13% g = 0% g = 6% 2.00 2.00 2.00 2.12 2.12. P 3 007 30.29... Slide 27 0 1.77 1.57 1.39 20.99 1234 r s =13% 25.71 g = 0% g = 6% 2.00 2.00 2.00 2.12 2.12. P 3 007 30.29... Slide 28 Terminal Value the (present) value, at the horizon date, of all future dividends after that date. Slide 29 Suppose a firm is expected to increase dividends by 20% in one year and by 15% in two years. After that dividends will increase at a rate of 5% per year indefinitely. If the last dividend was $1 and the required return is 20%, what is the price of the stock? Remember that we have to find the PV of all expected future dividends. Slide 30 Compute the dividends until growth levels off D 1 = 1(1.2) = $1.20 D 2 = 1.20(1.15) = $1.38 D 3 = 1.38(1.05) = $1.449 Find the expected future price at the beginning of the constant growth period: P 2 = D 3 / (R g) = 1.449 / (.2 -.05) = 9.66 Find the present value of the expected future cash flows P 0 = 1.20 / (1.2) + (1.38 + 9.66) / (1.2) 2 = 8.67 Slide 31 Nonconstant + Constant growth Slide 32 0 1.00 0.96 6.71 123 R = 20% 8.67 = P 0 g = 20%g = 15%g = 5% D 0 = 1.00 1.201.38 1.449 $1.449 P 2 = ^ 0.20 0.05 = $9.66 Slide 33 The Jones Company has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with a perpetual annual dividend of $5 per share. If the required return on this stock is currently 20 percent, what should be the stock's market value? Slide 34 The Jones Company has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with a perpetual annual dividend of $5 per share. If the required return on this stock is currently 20 percent, what should be the stock's market value? 5.20 = 25 Slide 35 A share of preferred stock pays a quarterly dividend of $2.50. If the price of this preferred stock is currently $50, what is the nominal annual rate of return? Slide 36 2.5 X 4 = 10/year 10/50 = 20% Slide 37 McKenna Motors is expected to pay a $1.00 per-share dividend at the end of the year (D1 = $1.00). The stock sells for $20 per share and its required rate of return is 11 percent. The dividend is expected to grow at a constant rate, g, forever. What is the growth rate, g, for this stock? P 0 = D 1 R g Slide 38 McKenna Motors is expected to pay a $1.00 per-share dividend at the end of the year (D1 = $1.00). The stock sells for $20 per share and its required rate of return is 11 percent. The dividend is expected to grow at a constant rate, g, forever. What is the growth rate, g, for this stock? D 1 /(R-g) = 20 1/(.11-g) = 20 1 = 2.2 20g -1.2 = -20g -1.2/-20 = g.06 = g Slide 39 A share of common stock has just paid a dividend of $2.00. If the expected long- run growth rate for this stock is 15%, and if investors require a 19% rate of return, what is the price of the stock? Slide 40 2.00 X (1.15) = 2.30 = D 1 P = 2.30 / (.19 -.15) P = 2.30 /.04 P = $57.5 Slide 41 A firms stock is selling for $10.50. They just paid a $1 dividend and dividends are expected to grow at 5% per year. What is the required return? Slide 42 P 0 = $10.50. D 0 = $1 g = 5% per year. What is the required return? Slide 43 P 0 = $10.50 D 0 = $1 g = 5% per year What is the dividend yield? 1(1.05) / 10.50 = 10% What is the capital gains yield? g = 5% Dividend Capital Gains Yield Yield Slide 44 Primary vs. Secondary Markets Primary = new-issue market Secondary = existing shares traded among investors Dealers vs. Brokers Dealer: Maintains an inventory Ready to buy or sell at any time Think Used car dealer Broker: Brings buyers and sellers together Think Real estate broker Slide 45 NYSE Merged with Euronext in 2007 NYSE Euronext merged with the American Stock Exchange in 2008 Members (Historically) Buy a trading license (own a seat) Designated market makers, DMMs (formerly known as specialists) Floor brokers Slide 46 Operational goal = attract order flow NYSE DMMs: Assigned broker/dealer Each stock has one assigned DMM All trading in that stock occurs at the DMMs post Trading takes place between customer orders placed with the DMMs and the crowd Crowd = Floor brokers Slide 47 Slide 48 Index funds outperform active funds 80 90% of the time.