Beruflich Dokumente
Kultur Dokumente
1
Forms of Risk
Diversifiable risk: Variability in return caused by
specific events to company
Can be eliminated through diversification
Market risk: Variability in return caused by market-
wide events
Often cannot be eliminated through diversification since
every stock would be affected. But some stocks are
affected more than others
Beta can be used as a measure of a stocks return sensitivity
in relation to general economic conditions
2
In Practice: Calculation of Beta
_ Historical returns
ri
.
.
20 Year rM ri
1 15% 18%
15
2 -5 -10
10 3 12 16
5
-5 0 5 10 15 20
rM
Regression line:
.
-5 ^ ^
ri = -2.59 + 1.44 rM
-10 Estimated Beta
of Stock i
Go back 3
Recap of Lecture 5
Most investors are risk averse dislike risk
and require higher rates of return to hold
riskier securities.
Higher risk higher required returns
CAPM says that higher market risk higher
required returns: ri = rRF + (rM rRF)bi
Not compensated for being exposed to diversifiable risk
4
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
5
Lecture 6: Stocks and Their Valuation, and Stock Market Efficiency
Learning Objectives
Understand the difference between stock price and intrinsic
value
Identify and explain the two models that can be used to
estimate a stocks intrinsic value: the discounted dividend
model and multiples of comparable firms method
Calculate the intrinsic value of a stock with constant growth
and non-constant growth
Calculate the stocks expected return, expected dividend
yield and expected capital gains yield
Understand the key features of preferred stock and calculate
the estimated value of preferred stock or its expected return
Discuss the importance of market efficiency, and explain why
some markets are more efficient than others
6
AB1201:
Financial Management
8
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
9
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
10
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
11
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
0 1 2 3
rs %
D1 D2 D3
^ D1 D2 D3 D
P0 ...
(1 rs ) (1 rs )
1 2
(1 rs ) 3
(1 rs )
12
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
14
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
15
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
16
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
17
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
1. $28.57
2. $30.29
3. $32.10
4. Not sure
18
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
g = ( 1 Payout ) (ROE)
g = ( Retention ratio ) (ROE)
A firm has been earning 15% on equity (ROE =
15%) and retaining 35% of its earnings
(dividend payout = 65%). This situation is
expected to continue.
g = (0.35) (15%)
= 5.25%
22
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Lessons Learnt 1
Discounted dividend model
General formula: ^ D1 D2 D3 D
P0 ...
(1 rs )1 (1 rs )2 (1 rs )3 (1 rs )
D (1+ g) D
P0 = 0 = 1
rs g rs g
24
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Supernormal Growth
A stock has just announced a dividend of $2,
(i.e. D0 = 2). The dividend is expected to
grow (g) at 30% for three years before
achieving a constant growth of 6%? Given
rRF = 7%, rM = 12%, and b = 1.2, What is its
estimated intrinsic value?
This means we can no longer use just the
constant growth model to find stock value.
However, the growth does become constant
after three years.
25
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
0 r = 13% 1 2 3
3 4
s
...
g1 = 30% g1 = 30% g1 = 30% g2 = 6%
D0 = 2.00 2.600 3.380 4.394 4.658
4.658
P$ 3 $66.54
0.13 0.06
^ 2.600 3.380 4.394 66.54
P0
(1 rs )1 (1 rs ) 2 (1 rs ) 3
54.107
26
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
29
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiple of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
30
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Preferred Stock
Hybrid security.
Like bonds, preferred stockholders receive a
fixed dividend that must be paid before
dividends are paid to common
stockholders.
However, companies can omit preferred
dividend payments without fear of pushing
the firm into bankruptcy.
31
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Preferred Stock
If a preferred stock with an annual dividend
of $5 sells for $50, what is the preferred
stocks expected return?
D
Vp =
rp
$5
$50 =
rp
rp = $5
$50
= 0.10 =10%
32
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
D1
rs g rs rRF (rM rRF )b
P0
33
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
34
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
35
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Lessons Learnt 2
Discounted dividend model
Non-constant growth stockassume the growth does become
constant after a certain period
During non-constant growth, expected dividend yield and capital
gains yield are not constant
During constant growth, expected dividend yield and capital
gains yield are constant and expected gains yield = g.
Multiples of comparable firms approach is used to
estimate the stock price such as P/E, P/CF, and P/Sales
The preferred stocks expected return = D/Vp
The market is in equilibrium when two conditions occur:
The current market stock price equals its intrinsic value
Expected returns must equal required returns.
36
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
37
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
35
1 Feb 2008
30 Microsoft
announced
25
takeover
20
15
10
0
16-Jan-08
17-Jan-08
18-Jan-08
19-Jan-08
20-Jan-08
21-Jan-08
22-Jan-08
23-Jan-08
24-Jan-08
25-Jan-08
26-Jan-08
27-Jan-08
28-Jan-08
29-Jan-08
30-Jan-08
31-Jan-08
1-Feb-08
2-Feb-08
3-Feb-08
4-Feb-08
5-Feb-08
6-Feb-08
7-Feb-08
8-Feb-08
9-Feb-08
10-Feb-08
11-Feb-08
12-Feb-08
13-Feb-08
14-Feb-08
15-Feb-08
39
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Market Efficiency
Concepts of market efficiency are related to
the assumptions about what information is available to
investors and reflected in the price.
It is also possible that some markets are efficient while
others are not. The key factors are the size of the
company, and the communication between the
company and the analysts/investors.
Highly Highly
Inefficient Efficient
40
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Lessons Learnt 3
An efficient market refers to a market in
which prices are close to intrinsic value and
stocks seem to be in equilibrium.
If the stock prices already reflect all publicly
available information, they will be fairly
priced.
If the stock market is efficient, a person
cannot consistently earn abnormal returns or
beat the market except with luck or inside
information.
41
Stocks and their valuation > Constant growth stock approach> Calculating yield for constant growth stocks > What is the expected
future growth rate? > LL1 > Non-constant growth stock approach > Calculating yield for non-constant growth stocks > Multiples of
comparable firms approach > Preferred stock > What is market equilibrium? > LL2 > Stock market efficiency > LL3 > Conclusion
Where do We Stand?
Dividend growth model:
Value of a stock = PV of expected future
dividends, rs determined using SML
^ D1
Constant growth P0
rs - g
Non-constant growth