1 / 24

Chapter 18

Chapter 18. Equity Valuation. 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. Dividend Discount Models: General Model. V 0 = Value of Stock

dex
Download Presentation

Chapter 18

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter18 Equity Valuation

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

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

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

  6. Constant Growth Model • g = constant perpetual growth rate

  7. 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

  8. 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)

  9. Estimating Growth via historical info. • Dividend in 2000 was $1. • Dividend in 2006 was $1.80 • Growth is (1.80/1)^(1/6)-1 = 10.29%

  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. Free Cash Flow to Equity A much better model is to apply discount models to FCFE which may more accurately reflect a firms value. FCFE = Net Income + depreciation – Cap. Expend. – change in working capital – principal debt repayments + new debt issues. Apply model as per usual.

  15. Free Cash Flow to Equity • If the firm finances a fixed percentage of its capital spending and investments in working capital with debt, the calculation of FCFE is simplified. Let DR be the debt ratio, debt as a percentage of assets. In this case, FCFE can be written as • FCFE = NI – (1 – DR)(Capital Spending + change in Working Capital – Depreciation) • When building FCFE valuation models, the logic, that debt financing is used to finance a constant fraction of investments, is very useful. This equation is pretty common.

  16. Let’s look at an example http://faculty.etsu.edu/trainor/FNCE%203300/Lowes.doc Another interesting site you may want to use: http://caps.fool.com/Ticker.aspx?source=icaedilnk9950012&ticker=LOW

  17. Free Cash flow to the Firm • FCFF = EBIT(1-tax rate) + Dep. – Cap. Expenditures – Change in WC – Change in other assets. • Again, proceed as normal(replace dividends with FCFF) but discount at firms cost of capital. • You find value of firm. To find value of equity, simply subtract off debt.

  18. 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

  19. 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

  20. P/E Ratio with Constant Growth • b = retention ration • ROE = Return on Equity

  21. 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

  22. 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

  23. Pitfalls in Using PE Ratios • Flexibility in reporting makes choice of earnings difficult • Pro forma earnings may give a better measure of operating earnings • Problem of too much flexibility

  24. Other types of Valuation • Use Price/sales • Price/Cash flow • All relative valuation models rely on the market to be fairly valued. What is a good Price/Sales ratio? Relies on comparisons which may or may not be valued accurately.

More Related