Chapter No 7

2. Chapter No 7 Investment in Long term Securities

3. Lec# 1 Investment in Stocks By: Nusratullahnoori Email/ F.B : nusrat2008noori@yahoo.com

4. Investment Common Stock • The main features of the common stock: • Typically each common stock owned entitles an investor to one vote in corporate shareholders’ meeting. • Investor receives benefits in the form of dividends, capital gains or both. • typically the firm does not pay all its earnings in cash dividends; special form of dividend is stock dividend, in which the corporation pays in stocks rather than cash. • Common stock does not have a date on which the corporation must buy it back. But: some corporations pay cash to their shareholders by purchasing their own shares. These are known as share buybacks. CHAPTER 8 – Risk, Return and Portfolio Theory

5. Investment Common Stock • Main advantages of common stock : • The investment income is usually higher; • The investor can receive income in cash dividends; • Common stock has a very high liquidity and can easily be moved from one investor to the other; • Main disadvantages of common stock: • Common stock is more risky in comparison with many other types of securities; • The operating income is relatively low (the main income is received from the capital gain – change in stock price).

6. Final Presentation and Assignment Topics Total marks = 15 • Fundamental analysis for investment decision making in stocks: • E-I-C analysis for investment decision making in stocks: • Categories of stocks: • Strategies for investing in stocks:

7. Lec# 2 Stock Valuation By: Nusratullahnoori Email/ F.B : nusrat2008noori@yahoo.com

8. Investment in Common Stock What is valuation??? • It is a process that links risk and return to determine the worth of an asset. Key inputs: • There are three key inputs to valuation process. • 1. Cash flows • 2. Timing • 3. (RRR)Required Rate of Return

9. What is the value of an asset?? • The value of an asset is the present value of all future cash flows over the relevant time period. • The value of an asset can be determined by discounting the expected cash flows back to their present value by using (BVM) : V0= (Basic valuation model) Where Vo= value of the asset at time zero CF= cash flow expected at the end of year k = required rate/ discount rate n = relevant time period

10. What is stock valuation??? • In financial markets, stock valuation is the method of calculating values of companies and their stocks. (means finding intrinsic value) • The main use of these methods is to predict future market prices, and thus to profit from price movement of stocks that are judged Undervalued are bought, while stocks that are judged overvalued are sold, in the expectation that undervalued stocks will, on the whole, rise in value, while overvalued stocks will, on the whole, fall.

11. Stock valuation process: • The process goes through the following steps • 1. Forecasting of future cash flows for the stock. • 2. Forecasting of the stock price. • 3. Calculation of Present value of these cash flows. This result is intrinsic value of stock. • 4. Comparison of intrinsic value of stock and current market price of the stock • 5. Decision making whether to buy or to sell the stock.

12. What is the value of a stock??? • The value of common stock is the present value of all future dividends over an infinite time horizon. • It can be determined by using the basic stock valuation model/ dividend discount model (DDM) P0= (Stock valuation model)DDM = Where P0= present value of common stock D= per share dividend expected at the end of year k= required rate on common stock

13. Lec# 3 Stock Valuation Methods By: Nusratullahnoori Email/ F.B : nusrat2008noori@yahoo.com

14. Stock valuation • The stock valuation model which is also called Dividend discount model DDM given below P0= (stock valuation model)DDM = Result in different forms depending on different situations and factors: • Holding periods • Growth rates

15. 1. Holding periods • Single holding period: • Based on single holding period, DDM results in the following form: • P0= • Where • D1 = the amount of dividend expected to receive at the end of year. • S1= the selling price expected to realize at the end of year. • K= the RRR by the investor. • Multiple holding periods: • Based on multiple holding periods , DDM results in the following form: P0= Where D1-Dn = annual dividends. Sn= selling price expected to realize at the of period. K= RRR by investor. n= number of years/ holding period

16. Single holding period: • Example:” Suppose an investor expects to get $3.50 as dividend per share next year and hopes to sell the share @ $ 45 at end of holding period. The required rate of return is 25%. Find the present value of this stock??? P0 can found using following model P0= Hint: the investor would buy, hold, the stocks only if the current market price this stock is less then present value of stock.

17. Multiple holding periods: • Example : Suppose an investor expects to receive $ 3.50, 4.50, 5.00, 5.50, and 6.00 at the end of 1st , 2nd , ……. Orderly, and hopes to sell this stock @ $ 65 at the end of holding period. If the investor’s RRR is 35% then Find present value of this stock. And decide if the investor would buy or hold the stock ???? P0=

18. Solve these Questions • Suppose an investor expects to get $3.50 as dividend per share next year and hopes to sell the share @ $ 45 at end of holding period. The required rate of return is 25%. Find the present value of this stock??? • Suppose an investor expects to receive $ 3.50, 4.50, 5.00, 5.50, and 6.00 at the end of 1st , 2nd , ……. Orderly, and hopes to sell this stock @ $ 65 at the end of holding period. If the investor’s RRR is 35% then Find present value of this stock. And decide if the investor would buy or hold the stock ???? Hint : Use single / multiple holding period Models

19. 2. Growth rates What is growth Rate??? • The rate at which the cash flow of a stock is expected to grow or increase is known as growth rate. • The annualized percentage rate of growth that a particular stock's dividend undergoes over a period of time. • A history of strong dividend growth could mean that future dividend growth is likely, which can signal long-term profitability for a given company.

20. How to calculate growth rate? • The growth rate in dividends is calculated by using following formula: • g = D0 – (Dt-1) ÷ Dt-1 Where g = growth rate Do = present dividend Dt = past dividend If the future dividend on a stock is $7.50 and past dividend is $4.00, then what is the growth rate??

21. 2. Growth rates • Growth rate of dividend on a stock can be the followings; • 1. Zero growth rate • 2. Constant growth rate Based on each growth rate the dividend discount model result in different forms as shown in following slides.

22. Growth rates Models • Zero growth rate: Po= where Po = present value Do = present dividend per year k = Required rate return Ex: a company gives dividend of $ 5.50 per year with zero growth rate. The required rate of return is 30% find the present value.

23. Growth rates Models • 2. Constant growth rate P0= and D1 = D0(1+g . One year Or P0= . Multiple years Ex : A corporation pays $3 per share as dividend and has a policy to grow the dividend by 7% per year in future. If the required rate is 15% : • find the Po from given data • If the growth rate is constant for 5 year then what will be Po of this stock????

24. Solve these questions • Ex1: A company gives dividend of $ 7.50 per year with zero growth rate. The required rate of return is 20% find the present value. Ex2: A corporation pays $5 per share as dividend and has a policy to grow the dividend by 10% per year in future. If the required rate is 25% : • find the Po from given data • If the growth rate is constant for 5 year then what will be Po of this stock????

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