investment in long term securities investment in stocks
TRANSCRIPT
Chapter No 7
Investment in Long term Securities
CHAPTER 8 – Risk, Return and Portfolio Theory 8 - 4
Investment Common Stock The main features of the common stock:Typically each common stock owned entitles an
investor to one vote in corporate shareholders’ meeting.
Investor receives benefits in the form of dividends, capital gains or both.
typically the firm does not pay all its earnings in cash dividends; special form of dividend is stock dividend, in which the corporation pays in stocks rather than cash.
Common stock does not have a date on which the corporation must buy it back. But: some corporations pay cash to their shareholders by purchasing their own shares. These are known as share buybacks.
Main advantages of common stock :The investment income is usually higher;The investor can receive income in cash
dividends;Common stock has a very high liquidity
and can easily be moved from one investor to the other;
Main disadvantages of common stock:
Common stock is more risky in comparison with many other types of securities;
The operating income is relatively low (the main income is received from the capital gain – change in stock price).
Investment Common Stock
1. Fundamental analysis for investment decision making in stocks:
2. E-I-C analysis for investment decision making in stocks:
3. Categories of stocks:4. Strategies for investing in stocks:
Final Presentation and Assignment Topics
Total marks = 15
What is valuation???It is a process that links risk and return
to determine the worth of an asset.
Key inputs:There are three key inputs to valuation
process.1. Cash flows 2. Timing 3. (RRR)Required Rate of Return
Investment in Common Stock
What is the value of an asset??The value of an asset is the present value of
all future cash flows over the relevant time period.
The value of an asset can be determined by discounting the expected cash flows back to their present value by using (BVM) :
V0= (Basic valuation model)WhereVo= value of the asset at time zeroCF= cash flow expected at the end of yeark = required rate/ discount raten = relevant time period
In financial markets, stock valuation is the method of calculating values of companies and their stocks. (means finding intrinsic value)
The main use of these methods is to predict future market prices, and thus to profit from price movement of stocks that are judged Undervalued are bought, while stocks that are judged overvalued are sold, in the expectation that undervalued stocks will, on the whole, rise in value, while overvalued stocks will, on the whole, fall.
What is stock valuation???
Stock valuation process:The process goes through the following
steps1. Forecasting of future cash flows for the
stock.2. Forecasting of the stock price.3. Calculation of Present value of these cash
flows. This result is intrinsic value of stock.4. Comparison of intrinsic value of stock and
current market price of the stock5. Decision making whether to buy or to sell
the stock.
What is the value of a stock???The value of common stock is the present value
of all future dividends over an infinite time horizon.
It can be determined by using the basic stock valuation model/ dividend discount model (DDM)
P0= (Stock valuation model)DDM
=
WhereP0= present value of common stockD= per share dividend expected at the end of yeark= required rate on common stock
Stock valuationThe stock valuation model which is also
called Dividend discount model DDM given below
P0= (stock valuation model)DDM
=
Result in different forms depending on different situations and factors:1. Holding periods2. Growth rates
1. Holding periodsMultiple holding periods: Based on multiple
holding periods , DDM results in the following form:
P0=
Where D1-Dn = annual dividends.Sn= selling price expected to realize at the of period.K= RRR by investor.n= number of years/ holding period
Single holding period:
Based on single holding period, DDM results in the following form:
P0= Where D1 = the amount of dividend expected to receive at the end of year.S1= the selling price expected to realize at the end of year.K= the RRR by the investor.
Single holding period:Example:”Suppose an investor expects to get $3.50 as dividend per share next year and hopes to sell the share @ $ 45 at end of holding period. The required rate of return is 25%. Find the present value of this stock???P0 can found using following modelP0=
Hint: the investor would buy, hold, the stocks only if the current market price this stock is less then present value of stock.
Multiple holding periods:Example :Suppose an investor expects to receive $ 3.50, 4.50, 5.00, 5.50, and 6.00 at the end of 1st , 2nd , ……. Orderly, and hopes to sell this stock @ $ 65 at the end of holding period.If the investor’s RRR is 35% then Find present value of this stock. And decide if the investor would buy or hold the stock ????
P0=
Solve these Questions 1. Suppose an investor expects to get $3.50 as
dividend per share next year and hopes to sell the share @ $ 45 at end of holding period. The required rate of return is 25%. Find the present value of this stock???
2. Suppose an investor expects to receive $ 3.50, 4.50, 5.00, 5.50, and 6.00 at the end of 1st , 2nd , ……. Orderly, and hopes to sell this stock @ $ 65 at the end of holding period. If the investor’s RRR is 35% then Find present value of this stock. And decide if the investor would buy or hold the stock ????
Hint : Use single / multiple holding period Models
2. Growth ratesWhat is growth Rate??? The rate at which the cash flow of a
stock is expected to grow or increase is known as growth rate.
The annualized percentage rate of growth that a particular stock's dividend undergoes over a period of time.
A history of strong dividend growth could mean that future dividend growth is likely, which can signal long-term profitability for a given company.
How to calculate growth rate?The growth rate in dividends is
calculated by using following formula:g = D0 – (Dt-1) ÷ Dt-1Where g = growth rateDo = present dividendDt = past dividend If the future dividend on a stock is $7.50 and past dividend is $4.00, then what is the growth rate??
Growth rate of dividend on a stock can be the followings;
1. Zero growth rate2. Constant growth rateBased on each growth rate the dividend discount model result in different forms as shown in following slides.
2. Growth rates
1. Zero growth rate:Po= wherePo = present valueDo = present dividend per yeark = Required rate returnEx: a company gives dividend of $ 5.50 per year with zero growth rate. The required rate of return is 30% find the present value.
Growth rates Models
Growth rates Models 2. Constant growth rateP0= and D1 = D0(1+g . One yearOr
P0= . Multiple yearsEx : A corporation pays $3 per share as dividend and has a policy to grow the dividend by 7% per year in future. If the required rate is 15% :1. find the Po from given data2. If the growth rate is constant for 5 year
then what will be Po of this stock????
Solve these questionsEx1: A company gives dividend of $ 7.50 per
year with zero growth rate. The required rate of return is 20% find the present value.
Ex2: A corporation pays $5 per share as dividend and has a policy to grow the dividend by 10% per year in future. If the required rate is 25% :1. find the Po from given data2. If the growth rate is constant for 5 year
then what will be Po of this stock????
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