Common Stock - Ownership shares in a publicly held
corporation.
Secondary Market - market in which already issued securities
are traded by investors.
Dividend - Periodic cash distribution from the firm to the
shareholders.
P/E Ratio - Price per share divided by earnings per share
Book Value - Net worth of the firm according to the balance sheet.
Liquidation Value - Net proceeds that would be realized by selling the firm’s
assets and paying off its creditors.
Market Value Balance Sheet - Financial statement that uses market value of
assets and liabilities.
Dividend Discount Model - Computation of today’s stock price which states
that share value equals the present value of all expected future dividends.
Div1 Div2 Div H PH
P0 ...
(1 r ) (1 r )
1 2
(1 r ) H
H - Time horizon for your investment.
Current forecasts are for XYZ Company to pay dividends of $3, $3.24, and
$3.50 over the next three years, respectively. At the end of three years you
anticipate selling your stock at a market price of $94.48. What is the price of
the stock given a 12% expected return?
3.00 3.24 . 94.48
350
PV
(1.12) (1.12)
1 2
(1.12) 3
PV $75.00
If we forecast no growth, and plan to hold out stock indefinitely, we will
then value the stock as a PERPETUITY.
Div1 EPS1
Perpetuity P0 or
r r
Assumes all earnings are
paid to shareholders.
A version of the dividend growth model in which dividends grow at a
constant rate (Gordon Growth Model).
r = Expected Rate of Return.
g = Growth Rate.
Assumptions:
- Dividend grows at a steady rate g
- r > g.
Div 0 (1 g ) Div1
P0
(r g ) (r g )
A version of the dividend growth model in which
dividends grow at a supernormal rate first and then
continue at a constant rate thereafter.
The percentage yield that an investor forecasts from a specific investment over a set period of
time. Sometimes called the market capitalization rate.
r = Dividend Yield + Capital Gain/Appreciation.
Div1 P1 P0
Expected Return r
P0 P0
If Fledgling Electronics is selling for $100 per share today and is expected to
sell for $110 one year from now, what is the expected return if the dividend
one year from now is forecasted to be $5.00?
5 110 100
Expected Return .15
100
If a firm elects to pay a lower dividend, and reinvest the funds, the stock
price may increase because future dividends may be higher.
Payout Ratio - Fraction of earnings paid out as dividends.
Plowback Ratio - Fraction of earnings retained by the firm.
Growth can be derived from applying the return on equity to the percentage
of earnings plowed back into operations.
g = return on equity X plowback ratio
Our company forecasts to pay a $8.33 dividend next year, which represents
100% of its earnings. This will provide investors with a 15% expected return.
Instead, we decide to plow back 40% of the earnings at the firm’s current
return on equity of 25%. What is the value of the stock before and after the
plowback decision?
No Growth With Growth
8.33 g .25 .40 .10
P0 $55.56
.15
5.00
P0 $100.00
.15 .10
An alternative valuation comes from valuing cash flows available to
stockholders directly.
Useful for companies that pay no dividends.
If CFs are defined as those available to all investors, WACC should be used
If CFs are defined as those available to common stockholders, ke from CAPM
should be used.
