Chapter 5: Valuation of

Securities

Prepared by Imroz Mahmud,

A s s i s t a n t P r o f e s s o r, D B A , U A P
Learning Objectives

LO1- A brief overview of Bangladesh’s Stock Market.

LO2- Features of common and preferred stock.

LO3- How to value preferred stocks.

LO4- How to value common stocks.

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Overview of Bangladesh Stock Market

Regulator Exchanges Facilitator

• BSEC • DSE • CDBL
• CSE • Investment
Banks

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Underwriters

 Investment banks that act as intermediaries between a

company selling securities and the investing public.
 Common services include:
• Formulating the method used to issue the securities.
• Pricing the new securities.
• Selling the new securities.

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Overview of Bangladesh Stock Market (DSE)

USD 52 Billion
343 Listed 10 Bonds & Equity Market
Companies Debentures Capitalization

221 37 Mutual
Treasury
Bonds
Funds 50%
Top Ten Companies’
Equity Market
Capitalization

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Source: DSE Website, Accessed on July 2021
Types of Stock

Common Stock

Preferred Stock

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Common vs Preferred Stock

Common stock is a security • Voting rights.

that represents ownership in a • Higher return (also entails higher risk).
corporation • Residual claims.

Preferred stock has preference

over common stock in the • No voting rights.
payment of dividends and in • Fixed income (dividend), stable return.
the distribution of corporate • Paid before common stockholders during liquidation.
assets

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Common & Exceptional Features

Common Stock Classes Preferred Stock

• Facilitate unequal voting rights • Cumulative or non-cumulative

• Purpose: Maintain control over the dividend
company • Convertible
• Callable/Redeemable
• May be granted voting right if
dividend is unpaid for quite some
time

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Primary vs. Secondary Markets

Primary Market refers to the original sale of securities by

corporations and governments.
• Transactions: Public Offering and Private Placement

The secondary markets are those in which these

securities are traded after the original sale.
• Example: DSE, CSE, NYSE

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Types of Public Issue

General • An issue of securities offered for sale to the general

public on a cash basis.
Cash Offer

Rights • Securities are initially offered only to existing owners.

Offer • Allows stockholders to purchase additional shares at a
price below the market price.
• It protects existing shareholders from dilution of
ownership.

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Common Stock Valuation

Stock Valuation Cash flows are unknown

Difficulties in

The life of the investment is essentially

forever/perpetual
No way to easily observe the required rate of
return (or discount rate)

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Example 1: Common Stock Valuation

 Imagine that you are considering buying a share of stock today. You plan
to sell the stock in one year. You somehow know that the stock will be
worth 70 taka at that time. You predict that the stock will also pay a Tk.
10 per share dividend at the end of the year. If you require a 25 percent
return on your investment, what is the most you would pay for the
stock?

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Stock Valuation Methods

Dividend
Discount Model Price-Earnings
Method

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Dividend Discount Model-Some Assumptions

 We have to make some simplifying assumptions about the pattern of

future dividends:
Assumption 1

Dividend has zero growth rate

Assumption 2

Dividend grows at a constant rate

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Zero Growth

 Similar to a preferred stock.

 This stock can be viewed as an ordinary perpetuity
 Example 2: Suppose the Paradise Prototyping Company has a policy of
paying a $10 per share dividend every year. If this policy is to be
continued indefinitely, what is the value of a share of stock if the
required return is 20 percent?

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Constant Growth

 The assumption of steady dividend growth might strike you as peculiar.

 For many companies, steady growth in dividends is an explicit goal.
 If dividend grows at a steady rate (g) then the dividend at time, t equals
 𝐷𝑡 = 𝐷0 × (1 + 𝑔)𝑡

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Example 3

 The Hedless Corporation has just paid a dividend of $3 per share.

The dividend of this company grows at a steady rate of 8 percent per
year. Based on this information, what will the dividend be in five
years?

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Dividend Growth Model

 An asset with cash flows that grow at a constant rate forever is called a growing perpetuity.
 As long as r > g , value of a stock is:

𝐷𝑡 × (1 + 𝑔) 𝐷𝑡+1
𝑃𝑡 = 𝑜𝑟 𝑃𝑡 =
𝑟−𝑔 𝑟−𝑔
 This elegant result goes by different names.
 Dividend growth model.
 Dividend discount model.
 Gordon growth model.

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Dividend Growth Model

 Example 4: Suppose the current dividend is Tk. 3, required return is 12 percent and
constant growth rate is 7 percent. What’s the price of the stock?

 We can use this model to get the price at any future point.

 Example 5: Using the previous example, calculate the price of the stock at year 5.

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Example 6

 The next dividend for the Gordon Growth Company will be $4 per share.
Investors require a 16 percent return on companies such as Gordon.
Gordon’s dividend increases by 6 percent every year. Based on the
dividend growth model, what is the value of Gordon’s stock today?

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Valuation Using Price-Earnings
 Obvious problems with Dividend Growth Model are
 Many companies don’t pay dividends, or
 Have unpredictable dividend growth rates

 A common solution: use PE ratio

 𝑃𝑡 = Benchmark PE ratio x 𝐸𝑃𝑆𝑡

 The benchmark PE ratio comes from either

 Industry average/median, or
 Company’s historical PE ratio
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Example 7: Stock Valuation and PE

 The Sleeping Flower Co. has earnings of $1.75 per share. The benchmark
PE for the company is 18 times. What stock price would you consider
appropriate?

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Example 8: Stock Valuation and PE

 Sully Corp. currently has an EPS of $2.35, and the benchmark PE for the
company is 21 times. Earnings are expected to grow at 7 percent per
year.
i. What is your estimate of the current stock price?
ii. What is the target stock price in three year?

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How to Pick a Good Share

Governance Business Financials Valuation

• Is the company • Does it have any • What’s the rate • Is the company
well governed? competitive of return? undervalued or
• Does it run by advantage? • How much is the overvalued?
competent • How is the net cash flow?
management? growth • What’s the
prospect? position of asset
and liability?

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Example: How Good An Investment Can Be?
Say, you invest Tk 100,000 in 2010
Share Price: Tk 100
No. of Shares Purchased: 1,000

Gave 200% stock dividend in 2018 & 2020

Regular hefty cash dividend 450%+
2010 2020
Profit
BDT 2.9 bn
after tax
BDT 10.8 bn No. of shares today: 9,000
increased
Share Price as on Aug 31, 2021: Tk 582.50
272%
2010 2020
Market Value of your investment today:
Cap.
BDT 45 bn BDT 309 bn
Increased Tk 5,242,500
586%
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Final words

 “Buying stocks is like trying to anticipate who will win a beauty contest. You
want to choose not the person who you think is the most beautiful but the
person you think everyone else will see as most beautiful”.
- John Maynard Keynes
Sophisticated investors need to understand that the investment is not only a
game of numbers, it’s also a game of psychology.

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End of Chapter