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Stock Valuation and Intrinsic Value Analysis Overview

Explore preferred and common stock valuation methods, dividend growth models, and key stock characteristics to make informed investment decisions. Understand intrinsic value calculation and asset valuation principles.

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Stock Valuation and Intrinsic Value Analysis Overview

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  1. Chapter 8

  2. Security Valuation • In general, the intrinsic value of an asset = the present value of the stream of expected cash flows discounted at an appropriate required rate of return.

  3. Preferred Stock A hybrid security: • it’s like common stock - no fixed maturity. • technically, it’s part of equity capital. • it’s like debt - preferred dividends are fixed. • missing a preferred dividend does not constitute default, but preferred dividends are cumulative.

  4. Preferred Stock • Usually sold for $25, $50, or $100 per share. • Dividends are often quoted as a percentage of par. • Example: In 1988, Xerox issued $75 million of 8.25% preferred stock at $50 per share. • $4.125 is the fixed, annual dividend per share.

  5. Common Stock • is a variable-income security. • dividends may be increased or decreased, depending on earnings. • represents equity or ownership. • includes voting rights. • Priority: lower than debt and preferred.

  6. Common Stock Characteristics • Claim on Income - a stockholder has a claim on the firm’s residual income. • Claim on Assets - a stockholder has a residual claim on the firm’s assets in case of liquidation. • Preemptive Rights - stockholders may share proportionally in any new stock issues. • Voting Rights - right to vote for the firm’s board of directors.

  7. D1 kcs - g Vcs = • Constant Growth Model • Assumes common stock dividends will grow at a constant rate into the future. • D1 = the dividend at the end of period 1. • kcs= the required return on the common stock. • g = the constant, annual dividend growth rate.

  8. Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

  9. Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%? D0 = $5, so D1 = 5 (1.10) = $5.50

  10. D1 5.50 kcs - g .15 - .10 Vcs = = = $110 Example • XYZ stock recently paid a $5.00 dividend. The dividend is expected to grow at 10% per year indefinitely. What would we be willing to pay if our required return on XYZ stock is 15%?

  11. D kcs - g Vcs = D1 Vcs k = ( ) + g Expected Return on Common Stock • Just adjust the valuation model

  12. D1 Po kcs = ( ) + g kcs = ( ) + .05 = 16.11% 3.00 27 Example • We know a stock will pay a $3.00 dividend at time 1, has a price of $27 and an expected growth rate of 5%.

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