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Valuing Stocks: Essentials of Corporate Finance and Market Analysis

This lecture by Rogério Mazali explores the fundamental principles of stock valuation as outlined in Chapter 7 of "Fundamentals of Corporate Finance". Key topics include understanding stock types, market versus book values, and the Dividend Discount Model. The session also covers the dynamics of primary and secondary stock markets, trading mechanisms, and the factors influencing market capitalization. It concludes with practical examples illustrating how to determine stock prices and intrinsic values, equipping students with essential tools for assessing investments in common and preferred stocks.

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Valuing Stocks: Essentials of Corporate Finance and Market Analysis

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  1. FINE 3010-01Financial Management Instructor: RogérioMazali Lecture 07: 10/17/2010

  2. FINE 3010-01Instructor: RogérioMazali Fundamentals of Corporate Finance Sixth Edition Richard A. Brealey Stewart C. Myers Alan J. Marcus McGraw Hill/Irwin Chapter 7: Valuing Stocks

  3. Agenda • Stocks and the Stock Market • Market Values, Book Values, and Liquidation Values • Valuing Common Stocks • Valuation by Comparables • Price and Intrinsic Value • The Dividend Discount Model

  4. Stocks and the Stock Market • Q: Chapter 1: FedEx. If you want to own a part of FedEx, what should you do? • A: Buy FedEx’s common stock. • Common Stock: • A share in the firm’s future profits (dividends); • Voting rights; • In case of bankruptcy, common stockholders are the last in line. • Preferred Stock: • A share in the firm’s future profits (dividends); • No voting rights; • In case of bankruptcy, preferred stock is senior to common stock, but junior to the company’s debt.

  5. Stocks and the Stock Market • Primary Markets: When a firm first issue stocks to the market. • First time issuing shares: Initial Public Offering (IPO). • Subsequent issues: Seasoned Equity Offering (SEO). • Auctioned by an underwriting investment bank • Secondary Markets: buying an existing share, “second-hand”, from a previous owner • Negotiated in a Stock Exchange (e.g., NYSE, AMEX, NASDAq); • Traders connected through electronic communication network

  6. Stocks and the Stock Market • How does the Stock Exchange works? • Ms. Jones: she owns FedEx shares and would like to sell • Mr. Brown: he would like to buy FedEx shares • Each gives brokers instructions about the amount to invest (disinvest) and the price they are prepared to transact. • Ms. Jones gives her broker a market order: sell at best available price; • Mr. Brown gives his broker a limit order: buy at prices smaller than or equal to a pre-specified limit. These orders are recorded in the exchange’s limit order bookuntil they are executed.

  7. Stocks and the Stock Market

  8. Stocks and the Stock Market

  9. Stocks and the Stock Market • Market Capitalization or market cap: • Price-earnings multiple or P/E ratio:

  10. Market Values, Book Values, and Liquidation Values • How traders decide on the price to pay for stock? • Book Value = Total Assets – Liabilities • # shares outstanding: 296 million. • Book Value of Equity per share: $42.76 • Book Value ≠ Market Value

  11. Market Values, Book Values, and Liquidation Values

  12. Market Values, Book Values, and Liquidation Values • Liquidation Value: value shareholders would obtain if firm sold all of its assets, paid all its debt, and distributed the rest back to shareholders • Liquidation Value does not consider intangible assets like brand value and R&D investment value • Liquidation Value ≠ Market Value

  13. Market Values, Book Values, and Liquidation Values • Difference between Book or Liquidation Values and Market Value is often attributed to going-concern value, which refers to three factors: • Extra Earning Power • Intangible Assets • Value of Future Investments • Market Value Balance Sheet:

  14. Valuing Common Stock • Valuation by Comparables: divide share price by measures of assets or earnings and compare against other firms in the same industry • Price-to-Book Value Ratio: • share price/Book Value per share • Price-Earnings Ratio: • Share price/Earnings per share

  15. Valuing Common Stock

  16. Price and Intrinsic Value • Chapter 6: Bonds are present value of coupons and face value • Stocks can be viewed the same way: • suppose you purchased Blue Skies, Inc. stock right after it paid dividends ; • You will hold it for one year; • Then you resell it on the market; • Payments in the period: • Dividend • Capital Gain/Loss

  17. Price and Intrinsic Value • Remember that stock returns can be calculated as: • If we solve for , we obtain:

  18. The Dividend Discount Model

  19. The Dividend Discount Model

  20. The Dividend Discount Model • Consider a firm with no growth opportunities • No growth => no new projects • No point in reinvesting profits • All profits will be redistributed to shareholders • Dividend per share = earnings per share

  21. Example • What is the value of a share of a firm that is expected to pay constant dividend of $2 per share forever, starting from next year? The required rate of return is 10%

  22. Example 2 • What is the value of a share of a firm that is not expected to grow, has 2 million shares outstanding, and had $60 million in net income last year? The required rate of return is 20%

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