INVESTMENT AND
PORTFOLIO MANAGEMENT
PRESENTED TO : DR. UMMARA SAHER
PRESENTED BY:
JAVERIA MUSHTAQ S/2019-1616
MAHAM AYUB S/2019-1626
SYRA KHAN S/2019-1640
COMMON STOCK
VALUATION
Stock valuation is the process of determining
the value of a share of stock in a company.
The holder of one share in a company that has
one million shares outstanding is actually the
owner of one-millionth of the company; the
value of that share should represent that
percentage of the company’s worth.
Common Stock Valuation
What cash flow will a shareholder receive
when owing share of common stock?
• Future dividends.
• Future sales of common stock shares
Basic Dividend valuation model accounts for
the PV of all future dividends.
Fundamental Analysis
Value
The regard that something is held to deserve the
importance, worth or usefulness of something.
Present value approach
Earlier money on the time is called present
value.
Future Value:
Later money on the timeline is called future
value.
Present Value Approach
Intrinsic value of a security is
Overvalue + Undervalue
Estimated intrinsic value compared to
the current market price
What if market price is different than estimated
intrinsic value?
Dividend Growth pattern
Assumption
The dividend valuation model requires the forecast of all future
Dividends. The following Dividend growth rate assumption simplify the
valuation process.
• No Growth
• Constant Growth
• Phases of Growth.
Zero/No Growth Model
The zero growth model assumes that will grow forever at the rate of contact
rate g=0 Constant Dividend
Ve=De/Ke (PV pv= R/1)
D Dividend Paid
ke investors return
Example
Stock ABC has an expected growth rate 0%. Each share of stock just
received an amount Dividend Rs/-3.24 per share. The appropriate
discount rate 15%. What is the value of the common stock?
D= Rs/_ 3.24
V= De/Ke
3.24/.15= Rs/ 21.60
Constant Growth Model
The constant growth model assume that dividend grow forever at
a constant rate. In this growth rate of return is constant.
Dividend Discount Model
Discount the dividend (Share Price)
Cost of equity (Expected)
Share price = dividend/Cost of Equities
Dividend Discount Model
Example:
Dividend = 3 MKT=30
Cost of equity = 18% =18
Share price = 3/18= 16.667
16.667multiply by 18%= 3 (paying)
30 multiply by 18%=5.4
Dividend Discount Model
Variable Growth Rate
A dividend valuation approach that allows
for a change in a dividend growth rate.
Types of Variable Growth Rate
Model
There are two further two types of model
a. 2 phase model
b. 3 phase model
2 PHASE MODEL
A dividend valuation approach that
allows for a change in a dividend
growth rate two times during the life
of stock.
3 PHASE MODEL
A dividend valuation approach that
allows for a change in dividend
growth rate 3 times during the life of
stock.
Example
Delphi Products corporation currently pays a
dividend of $2 per share, and this dividend is
expected to grow at a 15 percent annual rate for
three years, and then at a 10 percent rate for the
next three year, after which it is expected to grow
at a 5 percent rate forever. What value would you
place on the stock if an 18 percent rate of return
was required?
Phase-I (g1 = 15%p.a)
General Formula: Dn = Dox(1+g)n
Years Dividend Calculations / Answer (1+rd)n Percent Value
0 D0 = $2
1 D1 D1 = 2x(1+0.15)1 = 2.30 (1+0.18)1 = 1.18 $1.95
2 D2 D2 = 2x(1+0.15)2 = 2.65 (1+0.18)2 = 1.39 $1.90
3 D3 D3 = 2x(1+0.15)3 = 3.04 (1+0.18)3 = 1.64 $1.85
Phase-I Total $5.70
Phase-II(g2 = 10%p.a)
General Formula: Dn = Dox(1+g)n
Years Dividend Calculations / Answer (1+rd)n Percent Value
3 D3 = $3.04
4 D4 D4 = 3.04x(1+0.10)1 =3.35 (1+0.18)4 = 1.94 $1.73
5 D5 D5 = 3.04x(1+0.10)2 =3.68 (1+0.18)5 = 2.29 $1.61
6 D6 D3 = 3.04x(1+0.10)3= 4.05 (1+0.18)6 = 2.70 $1.50
Phase-II Total $4.83
Phase-III
Dividends are expected to grow for indefinite period of time at constant rate
Hence,
D6 will become Do & D7 will Become D1.
D7 = 4.05x (1+0.05)1 = 4.25
P = 32.69 This is the Value at the 7th year
Further,
discounting the value at 0th year
Final Step
= 5.70 + 4.83+10.27
= 20.8
Free Cash Flow Valuation
Many firms do not currently pay
dividends Theoretically, DDM will
work, but extremely difficult to
estimate when dividends will begin
and what growth rate will be
Alternative to DDM is calculating
present value of Free Cash Flow
Two Approaches:
1. Free Cash Flow to Equity (FCFE)
2. Free Cash Flow to the Firm (FCFF)
Free Cash Flow to Firm
Free cash flow to firm FCFF
represent the amount of cash flow
from operations available for
distribution after accounting for
depreciation expenses, taxes,
working capital, and investments.
Free
Cash Flow = Operating Cash
Flow – Capital Expenditure
Free Cash Flow to Firm
FCFF = FCFE + Interest Expense (1-tax rate) + Principal Repayment
- new Debt Issue – Preferred Dividends
Free Cash Flow to Equity
Free cash flow to equity is a measure
of how much cash is available to the
equity shareholders of the company
after all expenses, reinvestment and
debt are paid.
Free Cash Flow to Equity
FCFE= Net Income + Depreciation – Debt
repayments – capital expenditure – the
change in working capital +new debt
issues
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
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
P/E Ratio or Earnings
Multiplier Approach
Alternative approach often used by
security analysis
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
P/E Ratio
It is true defined that
P =E (P /E )
0 0 0 0
Where
P =the current stock price
0
E =the most recent 12 months earning
0
per share (EPS)
Type of P/E Ratio Approach
Stockprice is the product of two
variables when using this type of
approach
1.EPS
2.The P/E multiples
EPS (Earning per Share)
EPS indicates how much money a company
makes for each share of its stock and is a
widely used metric for estimating corporate
value. A higher EPS indicates greater value
because investors will pay more for a company's
shares if they think the company has higher
profits relative to its share price.
EPS=TOTAL EARNING/NO.OF
SHARES
P/E MULTIPLES
The P/E ratio measures the relationship
between a company's stock price and
its earnings per issued share. The P/E
ratio is calculated by dividing a
company's current stock price by its
earnings per share (EPS).
P/E Ratio=Stock price/Earning per
share
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, the
higher the justified P/E
The higher the required rate of return, k, the
lower the justified P/E
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
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
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
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 company’s total market value (price
times number of shares) divided by sales
Market valuation of a firm’s revenues
