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Stock Valuation PPT _ BEC DOMS ON FINACE

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					Stock Valuation




                  1
                Stock Valuation
 Learning Goals
  1. Explain the role that a company’s future plays in
     stock valuation.
  2. Develop a forecast of a stock’s cash flow, expected
     dividends and share price.
  3. Discuss the concepts of intrinsic value and required rates
     of return, and note how they are used.
  4. Determine the underlying value of a stock using various
     dividend valuation models.



                                                                  2
                Stock Valuation
 Learning Goals (cont’d)
  5. Use other types of present-value-based models to derive
     the value of a stock as well as alternative price-relative
     procedures.
  6. Gain a basic appreciation of the procedures used to value
     different types of stocks, from traditional dividend-paying
     shares to more growth-oriented stocks.




                                                                   3
      Valuing a Company and Its Future

 The single most important issue in the stock
  valuation process is what a stock will do in
  the future
 Value of a stock depends upon its future returns
  from dividends and capital gains/losses
 We use historical data to gain insight into the future
  direction of a company and its profitability
 Past results are not a guarantee of future results


                                                           4
Table 8.1 Comparative Dollar Based and
  Common-Size Income Statements




                                         5
    Steps in Valuing a Company
 Three steps are necessary to project key
  financial variables into the future:
   Step 1: Forecast future sales & profits
   Step 2: Forecast future EPS and dividends
   Step 3: Forecast future stock price




                                                6
    Step 2: Forecast Future EPS (cont’d)

 Example: Assume estimated profits are $6.5
  million, 2 million shares of common stock are
  outstanding, and the dividend payout ratio is
  estimated at 40%.

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                                              7
     Step 2: Forecast Future Dividends

 Forecasted Dividend Payout ratio
  based upon:
   “Naïve” approach based upon continued historical
    trends, or
   Historical trends adjusted for anticipated changes
    in operations or environment

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                                                         8
           Step 2: Forecast Future
             Dividends (cont’d)
 Example: Assume estimated profits are $6.5
  million, 2 million shares of common stock are
  outstanding, and the dividend payout ratio is
  estimated at 40%.

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                                              9
      Step 3: Forecast P/E Ratio
 Estimated P/E ratio based upon:
   “Average market multiple” of all stocks in the
    marketplace, or
   “Relative P/E multiple” of individual stocks
   Adjust up or down based upon expectations of
    economic conditions, general stock market
    outlook in near term, or anticipated changes in
    company’s operating results


                                                      10
       Step 3: Forecast P/E Ratio
 Estimated P/E ratio is function of several variables,
  including:
    Growth rate in earnings
    General state of the market
    Amount of debt in a company’s capital structure
    Current and projected rate of inflation
    Level of dividends




                                                          11
    Step 3: Forecast Future Stock Price
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  EPS figure for two more years and repeat the
  calculations.



                                                 12
Table 8.4 Summary Forecast Statistics,
    Universal Office Furnishings




                                         13
            Using Stock Valuation
 Once we have an estimated future stock price, we
  can compare it to the current market price to see if it
  may be a good investment candidate:
  current price   < estimated price   undervalued
  current price   = estimated price   fairly valued
  current price   > estimated price   overvalued




                                                        14
              The Valuation Process
   Valuation is a process by which an investor uses risk and
    return concepts to determine the worth of a security.
       Valuation models help determine what a stock ought to be worth
       If expected rate of return equals or exceeds our target yield, the stock
        could be a worthwhile investment candidate
       If the intrinsic worth equals or exceeds the current market value, the
        stock could be a worthwhile investment candidate
       There is no assurance that actual outcome will match
        expected outcome




                                                                                 15
       Required Rate of Return
 Required Rate of Return is the return
  necessary to compensate an investor for the
  risk involved in an investment.
   Used as a target return to compare forecasted
    returns on potential investment candidates

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                                                    16
 Required Rate of Return (cont’d)
 Example: Assume a company has a beta of
  1.30, the risk-free rate is 5.5% and the
  expected market return is 15%. What is the
  required rate of return for this investment?

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                                                 17
    Other Stock Valuation Methods
   Dividend Valuation Model
       Zero growth
       Constant growth
       Variable growth
   Dividend and Earnings Approach
   Price/Earnings Approach
   Other Price-Relative Approaches
       Price-to-cash-flow ratio
       Price-to-sales ratio
       Price-to-book-value ratio



                                      18
         Dividend Valuation Model:
               Zero Growth
 Uses present value to value stock
 Assumes stock value is capitalized value of its
  annual dividends
 Potential capital gains are really based upon
  future dividends to be received
 Assumes dividends will not grow over time
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                                               19
          Dividend Valuation Model:
               Constant Growth
 Uses present value to value stock
 Assumes stock value is capitalized value of its
  annual dividends
 Assumes dividends will grow at a constant rate over
  time
 Works best with established companies with history
  of steady dividend payments
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                                                    20
          Dividend Valuation Model:
               Variable Growth
 Uses present value to value stock
 Assume stock value is capitalized value of its annual
  dividends
 Allows for variable growth in dividend
  growth rate
 Most difficult aspect is specifying the appropriate
  growth rate over an extended period of time
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                                                      21
     Dividends-and-Earnings Approach

 Very similar to variable-growth DVM
 Uses present value to value stock
 Assumes stock value is capitalized value of its
  annual dividends and future sale price
 Works well with companies who pay little or
  no dividends
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                                                    22
   Price/Earnings (P/E) Approach
 Future price is based upon the appropriate P/E
  ratio and forecasted EPS
 Simple to use and easy to understand
 Widely used in stock valuation

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          k e S r
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                                               23
   Price-to-Cash-Flow (P/CF) Approach

 Similar to P/E approach, but substitutes
  projected cash flow for earnings
 Widely used by investors
 Many consider cash flow to be more accurate
  than profits to evaluate a stock
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                                             24
   Price-to-Sales (P/S) Approach
 Similar to P/E approach, but substitutes
  projected sales for earnings
 Useful for companies with no earnings or
  erratic earnings

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               S ph


                                             25
            Price-to-Book-Value
             (P/BV) Approach
 Similar to P/E approach, but substitutes book
  value for earnings

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                                                  26
Table 8.2 Average Market P/E Multiples
             1977–2006




                                         27
Table 8.5 Using the Variable-Growth DVM to
          Value Sweatmore Stock




                                             28

				
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