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Comprehensive Guide to Equity Valuation Models and Fundamental Stock Analysis

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efuru
21 diapositives · 377 Views · Oct 05, 2014

This chapter delves into various equity valuation models essential for fundamental stock analysis. It covers the basic types of models including balance sheet models, dividend discount models, and price/earning ratios. Learn how to estimate growth rates, intrinsic value, and market prices. Understand key concepts such as trading signals, no growth and constant growth models, and the impact of inflation on equity valuations. This guide serves as a valuable resource for both novice and experienced investors seeking to enhance their stock valuation skills.

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  1. Chapter 18 Equity ValuationModels

  2. 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

  3. 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

  4. Dividend Discount Models:General Model V0 = Value of Stock Dt = Dividend k = required return

  5. No Growth Model Stocks that have earnings and dividends that are expected to remain constant Preferred Stock

  6. No Growth Model: Example E1 = D1 = $5.00 k = .15 V0 = $5.00 / .15 = $33.33

  7. Constant Growth Model g = constant perpetual growth rate

  8. Constant Growth Model: Example E1 = $5.00 b = 40% k = 15% (1-b) = 60% D1 = $3.00 g = 8% V0 = 3.00 / (.15 - .08) = $42.86

  9. Estimating Dividend Growth Rates g = growth rate in dividends ROE = Return on Equity for the firm b = plowback or retention percentage rate (1- dividend payout percentage rate)

  10. Specified Holding Period Model PN = the expected sales price for the stock at time N N = the specified number of years the stock is expected to be held

  11. Partitioning Value: Growth and No Growth Components PVGO = Present Value of Growth Opportunities E1 = Earnings Per Share for period 1

  12. Partitioning Value: Example ROE = 20% d = 60% b = 40% E1 = $5.00 D1 = $3.00 k = 15% g = .20 x .40 = .08 or 8%

  13. Partitioning Value: Example Vo = value with growth NGVo = no growth component value PVGO = Present Value of Growth Opportunities

  14. 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

  15. P/E Ratio: No Expected Growth • E1 - expected earnings for next year • E1 is equal to D1 under no growth • k - required rate of return

  16. P/E Ratio with Constant Growth b = retention ratio ROE = Return on Equity

  17. 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

  18. 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

  19. Pitfalls in P/E Analysis • Use of accounting earnings • Historical costs • May not reflect economic earnings • Reported earnings fluctuate around the business cycle

  20. Inflation and Equity Valuation • Inflation has an impact on equity valuations • Historical costs underestimate economic costs • Empirical research shows that inflation has an adverse effect on equity values • Research shows that real rates of return are lower with high rates of inflation

  21. Potential Causes of Lower Equity Values with Inflation • Shocks cause expectation of lower earnings by market participants • Returns are viewed as being riskier with higher rates of inflation • Real dividends are lower because of taxes