Common Stock

Valuation

10-1
10-2
Fundamental Analysis

Present value approach

Capitalization of expected income
Intrinsic value based on the discounted
value of the expected stream of cash flows
Multiple of earnings approach
Valuation relative to a financial performance
measure
Justified P/E ratio

10-3
Present Value Approach

Intrinsic value of a security is

n Cash Flows
Value of security
t 1 ( 1 k)t
Estimated intrinsic value compared to
the current market price
What if market price is different than
estimated intrinsic value?

10-4
Required Inputs

Discount rate
Required rate of return: minimum expected
rate to induce purchase
The opportunity cost of dollars used for
investment
Expected cash flows
Stream of dividends or other cash payouts
over the life of the investment

10-5
Required Inputs

Expected cash flows

Dividends paid out of earnings
Earnings important in valuing stocks
Retained earnings enhance future earnings
and ultimately dividends
Retained earnings imply growth and future
dividends
Produces similar results as current dividends in
valuation of common shares

10-6
 Dividend Discount Model

Current value of a share of stock is the

discounted value of all future dividends

D1 D2 D
Pcs 1
2
...
( 1 kcs ) ( 1 kcs ) ( 1 kcs )
Dt
t
t 1 ( 1 kcs )

10-7
Dividend Discount Model

Problems:
Need infinite stream of dividends
Dividend stream is uncertain
Must estimate future dividends
Dividends may be expected to grow over
time
Must model expected growth rate of dividends
and need not be constant

10-8
Dividend Discount Model

Assume no growth in dividends

Fixed dollar amount of dividends reduces
the security to a perpetuity

D0
P0
kcs
Similar to preferred stock because dividend
remains unchanged

10-9
Examples

Misalkan PT A Tbk membayarkan

dividen tetap Rp100/ lembar saham
setiap tahun. Hitunglah berapa nilai
intrinsic saham perusahaan jika
required return yang diharapkan oleh
investor 15%.

10-10
Dividend Discount Model

Assume a constant growth in dividends

Dividends expected to grow at a constant
rate, g, over time
D1
P0
k g
D1 is the expected dividend at end of the
first period
D1 =D0 (1+g)

10-11
Examples

Misalkan tahun ini PT A Tbk membayarkan

dividen Rp100/ lembar saham. Dividen tersebut
diperkirakan akan tumbuh sebesar 7% setiap
tahunnya. Hitunglah berapa nilai intrinsic saham
perusahaan jika required return yang diharapkan
oleh investor 15%.
Hitunglah berapa perkiraan nilai saham
perusahaan pada tahun yang akan datang.
Berapa estimasi capital gain yang akan
didapatkan investor jika required returnnya
sama?

10-12
Perubahan pada growth rate

Misalkan tahun ini PT A Tbk membayarkan

dividen Rp100/ lembar saham. Dividen tersebut
diperkirakan akan tumbuh sebesar 10% setiap
tahunnya. Hitunglah berapa nilai intrinsic saham
perusahaan jika required return yang diharapkan
oleh investor 15%.

10-13
Perubahan pada required return

Misalkan tahun ini PT A Tbk membayarkan

dividen Rp100/ lembar saham. Dividen tersebut
diperkirakan akan tumbuh sebesar 7% setiap
tahunnya. Hitunglah berapa nilai intrinsic saham
perusahaan jika required return yang diharapkan
oleh investor 12%.

10-14
Example: Estimating the Dividend Growth Rate

One method for estimating the

growth rate is to use the historical
average
Year Dividend Percent Change
2003 1.23 (1.30 1.23) / 1.23 = 5.7%
2004 1.30 (1.36 1.30) / 1.30 = 4.6%
2005 1.36 (1.43 1.36) / 1.36 = 5.1%
2006 1.43 (1.50 1.43) / 1.43 = 4.9%
2007 1.50
Average = (5.7 + 4.6 + 5.1 + 4.9) / 4 = 5.1%

15
Advantages and Disadvantages of Dividend
Growth Model

Advantage easy to understand and

use
Disadvantages
Only applicable to companies currently
paying dividends
Not applicable if dividends arent growing
at a reasonably constant rate

16
Dividend Discount Model

Implications of constant growth

Stock prices grow at the same rate as the
dividends
Stock total returns grow at the required
rate of return
Growth rate in price plus growth rate in dividends
equals k, the required rate of return
A lower required return or a higher
expected growth in dividends raises prices

10-17
Dividend Discount Model

Multiple growth rates: two or more

expected growth rates in dividends
Ultimately, growth rate must equal that of
the economy as a whole
Assume growth at a rapid rate for n periods
followed by steady growth

t
n D0( 1 g1 ) Dn( 1 gc ) 1
P0 t
n
t 1 ( 1 k) k-g ( 1 k)
10-18
Dividend Discount Model

Multiple growth rates

First present value covers the period of
super-normal (or sub-normal) growth
Second present value covers the period of
stable growth
Expected price uses constant-growth model as of
the end of super- (sub-) normal period
Value at n must be discounted to time period
zero

10-19
Example: Valuing equity with growth of
30% for 3 years, then a long-run
constant growth of 6%

0 k=16% 1 2 3 4
g = 30% g = 30% g = 30% g = 6%
D0 = 4.00 5.20 6.76 8.788 9.315
4.48
5.02
5.63
59.68 P3 = 9.315
74.81 = P0 .10
Contoh

Misalkan tahun ini PT A Tbk membayarkan

dividen Rp100/ lembar saham. Dividen
tersebut diperkirakan akan tumbuh
sebesar 7% setiap tahunnya sampai tahun
ke 5 dan setelah itu dividen diperkirakan
akan tumbuh 8% selamanya. Hitunglah
berapa nilai intrinsik saham perusahaan
jika required return yang diharapkan oleh
investor 15%.

10-21
What About Capital Gains?

Is the dividend discount model only

capable of handling dividends?
Capital gains are also important
Price received in future reflects
expectations of dividends from that
point forward
Discounting dividends or a combination of
dividends and price produces same results

10-22
Other Discounted Cash Flows

Free Cash Flow to Equity (FCFE): What could

shareholders be paid?
FCFE = Net Inc. + Depreciation Change in
Noncash Working Capital Capital Expend. Debt
Repayments + Debt Issuance
Free Cash Flow to the Firm (FCFF): What cash
is available before any financing
considerations?
FCFF = EBIT (1-tax rate) + Depreciation Change
in Noncash Working Capital Capital Expend.
Use per share measures instead of dividends

10-23
Intrinsic Value

Fair value based on the capitalization

of income process
The objective of fundamental analysis
If intrinsic value >(<) current market
price, hold or purchase (avoid or sell)
because the asset is undervalued
(overvalued)
Decision will always involve estimates

10-24
P/E Ratio or Earnings Multiplier
Approach
Alternative approach often used by
security analysts
P/E ratio is the strength with which
investors value earnings as expressed
in stock price
Divide the current market price of the stock
by the latest 12-month earnings
Price paid for each $1 of earnings

10-25
P/E Ratio Approach

To estimate share value

Po estimated earnings
justified P/E ratio E1 Po /E1
P/E ratio can be derived from
D1 D1/E1
Po or Po /E1
k-g k-g
Indicates the factors that affect the
estimated P/E ratio

10-26
Contoh

Misalkan P/E Ratio PT B Tbk 20.

Hitunglah berapa perkiraan harga
perusahaan jika EPS diperkirakan
Rp200/saham?

10-27
Perubahan pada required return

Misalkan tahun ini PT A Tbk membayarkan

dividen Rp100/ lembar saham. Dividen tersebut
diperkirakan akan tumbuh sebesar 7% setiap
tahunnya. Hitunglah berapa PER perusahaan jika
jika required return yang diharapkan oleh
investor 15% dan EPS rata-rata dalam 12 bulan
terakhir Rp250.

10-28
P/E Ratio Approach

The higher the payout ratio, the higher

the justified P/E
Payout ratio is the proportion of earnings
that are paid out as dividends
The higher the expected growth rate, g,
the higher the justified P/E
The higher the required rate of return,
k, the lower the justified P/E

10-29
Understanding the P/E Ratio
Can firms increase payout ratio to increase
market price?
Will future growth prospects be affected?
Does rapid growth affect the riskiness of
earnings?
Will the required return be affected?
Are some growth factors more desirable than
others?
P/E ratios reflect expected growth and risk

10-30
P/E Ratios and Interest Rates

A P/E ratio reflects investor optimism

and pessimism
Related to the required rate of return
As interest rates increase, required
rates of return on all securities
generally increase
P/E ratios and interest rates are
indirectly related

10-31
Which Approach Is Best?

Best estimate is probably the present

value of the (estimated) dividends
Can future dividends be estimated with
accuracy?
Investors like to focus on capital gains not
dividends
P/E multiplier remains popular for its
ease in use and the objections to the
dividend discount model

10-32
Which Approach Is Best?

Complementary approaches?
P/E ratio can be derived from the constant-
growth version of the dividend discount
model
Dividends are paid out of earnings
Using both increases the likelihood of
obtaining reasonable results
Dealing with uncertain future is always
subject to error

10-33
Other Multiples

Price-to-book value ratio

Ratio of share price to stockholder equity as
measured on the balance sheet
Price paid for each $1 of equity
Price-to-sales ratio
Ratio of a companys total market value
(price times number of shares) divided by
sales
Market valuation of a firms revenues

10-34