CHAPTER 7 COMMON STOCK VALUATION
FIN501 investment analysis I
CHAPTER 7 COMMON STOCK VALUATION SECURITY ANALYSIS: BE CAREFUL OUT THERE Fundamental analysis: examination of a firm’s accounting statements and other financial and economic information to assess the economic value of a company’s stock o Includes earnings per share, cash flow, book equity value, and sales Cautionary note is there is good reason to believe that too-simple techniques that rely on widely available information are not likely to yield systematically superior investment results THE DIVIDEND DISCOUNT MODEL The economic value of a security is properly measured by the sum of its future cash flows, where the cash flows are adjusted for risk and the time value of money Dividend discount model (DDM): method of estimating the value of a share of stock as the present value of all expected future dividend payments, where dividends are adjusted for risk and the time value of money 2 3 T V(0) = D1/(1+k) + D2/(1+k) + D3/(1+k) + ... + DT/(1+k)
Constant growth rate model: a version of the dividend discount model that assumes a constant dividend growth rate T V(0) = [D0(1+g) / (k-g)] x [1 – (1+g / 1+k) ] ; where g ≠ k
Constant perpetual growth model: a version of the dividend discount model in which dividends grow forever at a constant rate, and the growth rate is strictly less than the discount rate o This method can only be applied to companies with a history of relatively stable earnings and dividend growth expected to continue into the distant future o The reason g
CHAPTER 7 COMMON STOCK VALUATION SECURITY ANALYSIS: BE CAREFUL OUT THERE Fundamental analysis: examination of a firm’s accounting statements and other financial and economic information to assess the economic value of a company’s stock o Includes earnings per share, cash flow, book equity value, and sales Cautionary note is there is good reason to believe that too-simple techniques that rely on widely available information are not likely to yield systematically superior investment results THE DIVIDEND DISCOUNT MODEL The economic value of a security is properly measured by the sum of its future cash flows, where the cash flows are adjusted for risk and the time value of money Dividend discount model (DDM): method of estimating the value of a share of stock as the present value of all expected future dividend payments, where dividends are adjusted for risk and the time value of money 2 3 T V(0) = D1/(1+k) + D2/(1+k) + D3/(1+k) + ... + DT/(1+k)
Constant growth rate model: a version of the dividend discount model that assumes a constant dividend growth rate T V(0) = [D0(1+g) / (k-g)] x [1 – (1+g / 1+k) ] ; where g ≠ k
Constant perpetual growth model: a version of the dividend discount model in which dividends grow forever at a constant rate, and the growth rate is strictly less than the discount rate o This method can only be applied to companies with a history of relatively stable earnings and dividend growth expected to continue into the distant future o The reason g
