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Basic Valuation Concepts

Basic Valuation Concepts. Dividend valuation models Constant growth Non-constant growth Finite/infinite holding period Earnings valuation models P/E Ratio based model Dividend and Earnings model Other Valuation models Price to Sales Price to Dividends Price to Earnings

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Basic Valuation Concepts

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  1. Basic Valuation Concepts • Dividend valuation models • Constant growth • Non-constant growth • Finite/infinite holding period • Earnings valuation models • P/E Ratio based model • Dividend and Earnings model • Other Valuation models • Price to Sales • Price to Dividends • Price to Earnings • Price to Cash flow • Price to Book Value

  2. Dn (1+Ke)n +. . + D1 (1+Ke)1 D3 (1+Ke)3 D2 (1+Ke)2 + + 1. General Dividend Models The value of a share of stock is equal to the present value of an expected stream of future dividends. P0= Where P0= Present value of the stock price Di = Dividend for each year Ke = Required rate of return (discount rate) Model assumes that the investor can determine the dividend for each period and the required rate of return.

  3. D0(1+g)1 (1+Ke)1 D1 (Ke - g) D0 (1+g)2 (1+Ke)2 D0 (1+g)3 (1+Ke)3 D0 (1+g)n (1+Ke)n + ... + + P0= Constant Growth Model P0= + For extremely long time (infinite holding period) periods, this formula reduces to if following conditions are met. 1. g is constant 2. Ke > g

  4. Required Return Ke = Required rate of return RF = Risk-free rate b = Beta Coefficient KM = Expected return for common stocks in the market (KM - RF) = Equity risk premium (ERP)

  5. A Nonconstant Growth Model 1. Divide time period into intervals of constant dividend growth 2. Calculate the dividend at the beginning of each period 3. Calculate the Present Value of each interval of constant growth 4. Price = Sum of the PVs

  6. Figure 7-1. JAYCAR Growth Pattern. Dividends per share 8% (years 11 to infinity) 20% (years 1-10) 1 5 10 15 20 25 30 35 40 45

  7. Non-constant growth illustration JAYCAR's Growth pattern first ten years P10 = D11 / (Ke - g) Dividend Year 11 = Div 10 x (1+ growth rate) = 5.15 ( 1.08) = 5.56 P10 = 5.56 / (12% - 8% ) = 5.56 / .04 = $139 Discount to Present: $139 / .322 = $44.76 P0 = $12.42 + $44.76 = $57.18

  8. 2. Combined Earnings and Dividend Model • The value of common stock can be viewed as a dividend stream plus a market price at the end of the dividend stream. • Earnings-per-share and dividends-per-share are estimated for some period. • Ending stock price estimated by using long-term PE ratio. • Stock Price = (Present value of dividend flow) + Present value of stock price

  9. Price Earnings Ratio • It indicates the price that investors are willing to pay for a firm’s earnings. • Published P/E ratios based on today’s price divided by the latest 12-month earnings. • P/E ratios can be a proxy for risk. The higher the P/E ratio relative to the market P/E ratio, the higher the risk.

  10. Price Earnings Ratio • P/E ratios vary across industries. • P/E ratios are also influenced by the political and economic conditions, management abilities and quality of earnings.

  11. Calculating Value based on relative P/E

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