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Valuation of Preferred and Common Stock

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					         Chapter 2:
Valuation of Stocks and Bonds




                                1
What is Value?

v   In general, the value of an asset is the price
    that a willing and able buyer pays to a willing
    and able seller

v   Note that if either the buyer or seller is not
    both willing and able, then an offer does not
    establish the value of the asset



                                                      2
Several Kinds of “Value”

v   There are several types of value, of which we
    are concerned with three:

    • Book Value - The asset’s historical cost less
      its accumulated depreciation
    • Market Value - The price of an asset as
      determined in a competitive marketplace
    • Intrinsic Value - The present value of the
      expected future cash flows discounted at
      the decision maker’s required rate of return    3
    Determinants of Intrinsic Value

v   There are two primary determinants of the intrinsic value
    of an asset to an individual:

    • The size and timing of the expected future cash flows
    • The individual’s required rate of return (this is determined by a
      number of other factors such as risk/return preferences, returns on
      competing investments, expected inflation, etc.)


v   Note that the intrinsic value of an asset can be, and often
    is, different for each individual (that’s what makes
    markets work)


                                                                            4
         Chapter 2:
Valuation of Stocks and Bonds

 2.3 Valuation of Preferred
           Stocks


                                5
      Preferred Stock Features
v   Preferred stock differs from common stock because it has preference over
    common stock on payment of dividends and in the distribution of
    corporation assets in the event of liquidation.
v   Preferred stock is a form of equity from a legal, tax, and regulatory
    standpoint.
v   Holders of preferred stock generally have no voting privileges.
v   However, holders of preferred stock are often granted voting and other
    rights if preferred dividends have not been paid for some time.
v   Preferred stock have a stated liquidating value.
v   The cash dividend is described in dollars per share.
v   A preferred dividend is not like bond interest
v   Dividends on preferred stock are either cumulative or non-cumulative.
v   Dividends not declared on cumulative preferred stock are carried
    forward and must be paid before common shareholders can receive
    anything

                                                                               6
     Features of preferred stock

v   A hybrid security
v   May be perpetuity or redeemable
v   Paid before common dividends.
v   Cumulative or Non-cumulative dividends
v   Dividends not a liability
v   Protective provisions (voting)
v   Call provisions & sinking funds
v   Convertible or Non-convertible
v   Usually non-voting and non-participative.
v   Priority-lower than debt, higher than stock.


                                                   7
Preferred Stock Valuation

Preferred stocks can usually be valued like a
perpetuity:



            Vp =       D
                       kp



                                                8
Example:

 Xerox preferred that pays $4.125 dividend
 per year. Suppose our required rate of
 return on Xerox preferred is 9.5%


               4.125
   Vp    =                 =   $43.42
              .095


                                             9
  Expected Rate of Return on Preferred

Just adjust the valuation model:

                 D
   kp =
        Vp

                                   D
                           kp =
                                   Po
                                         10
Example

 If we know the preferred stock price is $40,
 and the preferred dividend is $4.125, the
 expected return is:



           D           4.125
kp =               =              =    .1031
           Po             40

                                                11
    Valuation of redeemable preferred stock
v   The value of a preferred stock equals the present value of all
    future dividends
                           n
                                 D              M
                   Vp                   
                        t 1 (1  k p )     (1  k p ) n
                                        t


          Vp  Current va of preferencestock
                         lue
          D  periodical dividend
          n  life of the preferencestock
          k p  required rate of return on preferencestock
          M  maturity value
          Since the stream of dividends is an ordinary annuity,
                   Vp  D  PVIFAk p ,n  M  PVIFk p ,n
                                                                     12
         Chapter 2:
Valuation of Stocks and Bonds

 2.4 Valuation of Common
           Stocks


                                13
    Features of common stock
v   Residual income and asset claimants
    • Unlimited upside
    • First to suffer
v   Priority
    1. Debt
    2. Preferred Stock
    3. Common Stock
v   A firm cannot go bankrupt for not declaring dividends
v   Dividends and Taxes
    • Dividend payments are not considered a business
       expense, therefore, they are not tax deductible
    • Dividends received by individuals are taxed as ordinary
       income
                                                            14
    Features of Common Stock

v   The term common stock usually implies the shareholder
    has no special preference either in dividends or in
    bankruptcy.
v   Shareholders, however, control the corporation through
    their right to elect the directors. The directors in turn hire
    management to carry out their directives.
v   Directors are elected at an annual shareholders’ meeting by
    a vote of the holding of a majority of shares present and
    entitled to vote.




                                                                 15
Common Stock Features

v    Shareholders usually have the following rights
     also:

    1. The right to share proportionally in dividends
       paid.
    2. The right to share proportionally in assets
       remaining after liabilities and preferred
       shareholders have been paid in a liquidation.
    3. The right to vote on stockholder matters of great
       importance, such as a merger or new share
       issuance.
                                                           16
Common Stock Features

Dividends

v   Dividend payments are at the discretion of the BoD.
v   Dividends are not a liability of the corporation until
    declared by the BoD.
v   Dividends are not tax deductible for the issuing
    corporation.




                                                             17
Common Stock Features

Classes of Stock

v   Some firms have more than one class of common
    stock; often, the classes are created with unequal
    voting rights.
v   Non-voting shares must receive dividends no lower
    than dividends on voting shares.
v   A primary reason for creating dual classes of stock
    has to do with control of the firm.



                                                          18
Common Stock Valuation

v   Just like with bonds, the first step in valuing
    common stocks is to determine the cash flows
v   For a stock, there are two:
    • Dividend payments
    • The future selling price
v   Again, finding the present values of these
    cash flows and adding them together will
    give us the value


                                                      19
Cash flows for stockholders

v   If you buy a share of stock, you can receive
    cash in two ways

    • The company pays dividends
    • You sell your shares, either to another investor in
      the market or back to the company


v   As with bonds, the price of the stock is the
    present value of these expected cash flows

                                                            20
Common Stock Valuation

Unlike bonds, valuing common stock is more difficult.
Why?

1.   The timing and amount of future cash flows is not
     known.
2.   The life of the investment is essentially forever.
3.   There is no way to observe the rate of return that
     the market requires.



                                                          21
Some Notes About Common Stock

v   In valuing the common stock, we have to make two
    assumptions:
    • We know the dividends that will be paid in the future
    • We know how much you will be able to sell the stock for in
      the future
v   Both of these assumptions are unrealistic, especially
    knowledge of the future selling price
v   Furthermore, suppose that you intend on holding on
    to the stock for twenty years, the calculations would
    be very tedious!


                                                                   22
Common Stock: Some Assumptions

v   We cannot value common stock without making
    some simplifying assumptions
v   If we make the following assumptions, we can derive
    a simple model for common stock valuation:
v   Assume:
    • Your holding period is infinite (i.e., you will never sell the
      stock)
    • The dividends will grow at a constant rate forever (this is
      only one example of assumption that simplifies the problem)
v   Note that the second assumption allows us to predict
    every future dividend, as long as we know the most
    recent dividend

                                                                       23
Common Stock Valuation:
Dividend Discount Model




                          24
     Single-Period Valuation Model

v   Suppose you are thinking of purchasing the stock of Moore Oil, Inc.
    and you expect it to pay a $2 dividend in one year and you believe
    that you can sell the stock for $14 at that time. If you require a return
    of 20% on investments of this risk, what is the maximum you would
    be willing to pay?

v   Remember, the cash flows to the stockholder is simply the dividends
    received + the future sales price


                     D1         P1
             Vc            
                  (1  k c ) (1  k c )
                                                                                25
    Single Holding Period

You expect XYZ stock to pay a $5.50 dividend at the end of
   the year. The stock price is expected to be $120 at that
 time. If you require a 15% rate of return, what would you
                   pay for the stock now?

     ?                                5.50 + 120

     0                                       1
                   Ans: $ 109.13
                                                          26
What happens if ?

The price of common stock is expected to grow
at the rate of g % annually ?
The current price P0 becomes Po(1+g) a year
hence.

        D1       Po (1  g)   D1
Po                        
     (1  k c ) (1  k c ) (k c  g )

                                                27
Example

The expected dividend per share on the equity share of
Roadking Limited is Rs 2.00. The dividend per share of
Roadking Limited has grown over the past five years at
the rate of 5 % per year. This growth rate will continue in
future. Further, the market price of the equity share of
Roadking Limited, too, is expected to grow at the same
rate. What is a fair istimate of the intrinsic value of the
equity share of Roadking Limited if the required rate is
15% ?

        D1           2
Po                           Rs 20.00
     (k c  g) (0.15  0.05 )
                                                              28
Expected Rate of Return

What rate of return can the investor expect, given the
current market price and forecasted values of dividend
and share price ?


             Kc = (D1 / Po)+ g




                                                         29
       Multi-period Valuation Model

       v   The value of a stock today (its current price) is in
           theory equal to the present value of all future
           dividends plus that of the selling price.


       D1       D2         D3         D4                         Dn              Pn
P0                                           ..........
                                                          .                
     1  k c (1  k c ) (1  k c ) (1  k c )
                       2          3           4
                                                              (1  k c ) n
                                                                             (1  k c ) n
      n
            Dt              Pn
                    
    t 1 (1  k c )     (1  k c ) n
                    t




                                                                                      30
 Multi-period Valuation Model

But common shares have no maturity period –
they may be expected to bring a dividend stream
of infinite duration
         D1       D2           D3          D4                         D
P0                                                ..........
                                                               .
       1  k c (1  k c ) 2 (1  k c )3 (1  k c ) 4               (1  k c ) 
       
           Dt
  
   t 1 (1  k c ) t



                                                                                  31
Multi-period Valuation Model

v   That was the generalized multi-period
    valuation formula – which is general enough
    to permit any dividend pattern – constant,
    rising, declining or randomly fluctuating.

v   For practical applications, it is helpful to
    make simplifying assumptions about the
    pattern of dividend growth.


                                                   32
     Commonly used assumptions types:

1.   The dividend per share remains constant forever, implying
     that the growth rate is nil (THE ZERO GROWTH MODEL)
2.   The dividend per share grows at a constant rate per year
     forever (THE CONSTANT GROWTH MODEL)
3.   The dividend per share grows at a constant rate for a finite
     period, followed by a constant normal rate of growth
     forever thereafter (THE TWO STAGE MODEL)
4.   The dividend per share, currently growing at an above-
     normal rate, experiences a gradually declining rate of
     growth for a while. Thereafter it grows at a constant
     normal rate (THE “H” MODEL)

                                                                33
Zero Growth Model
Assuming that the dividend per share remains
constant year after year, at a value of D, the
valuation model becomes as that of the
perpetual preference stock;

       D          D         D         D                           D
P0                                           ..........
                                                          .
     1  k c (1  k c ) (1  k c ) (1  k c )
                       2          3           4
                                                              (1  k c ) 
           D          D
                   
   t 1 (1  k c )
                   t
                       kc


                                                                             34
Example

 Suppose stock is expected to pay a $0.50
 dividend every quarter and the required
 return is 10% with quarterly compounding.
 What is the price?


       D    0.5
  P0            $ 20.00
       k c 0.025
                                             35
       Constant Growth model

         Assumes that the dividend per share grows at
         a constant rate (g)
       D1     D1 (1  g ) D1 (1  g ) 2 D1 (1  g ) 3                    D1 (1  g ) n
P0                                                   .......... .             n 1
                                                                                          .......
     1  k c (1  k c ) 2
                            (1  k c ) 3
                                           (1  k c ) 4
                                                                         (1  k c )

         With a little algebra, this reduces to:

                                D 0 (1  g)    D1
                           P0              
                                 kc - g       kc - g

                                                                                              36
Example 1

 Suppose Big K, Inc. just paid a dividend of
 $5. It is expected to increase its dividend by
 2% per year. If the market requires a return
 of 15% on assets of this risk, how much
 should the stock be selling for?

       5(1  0.02) 5.10
  P0                   $ 39.23
       0.15 - 0.02 0.13

                                                  37
Example 2

 Suppose Comolli, Inc. is expected to pay a $2
 dividend in one year. If the dividend is
 expected to grow at 5% per year and the
 required return is 20%, what is the price?




             Ans: $ 13.33

                                                 38
Example 3

 Griggs Inc. last dividend (D0) was $2. The dividend
 growth rate (g) is a constant 5%. If the required
 return (kc) = 10%, what is P0?



               2(1.05 )
       P0                 $42
            (. 10  .05 )

                                                       39
    Example 4

      Overton Corp. just paid a $2 dividend. If
      the dividends will grow at a constant rate of
      5% in the future, what is the stock price in 4
      years (at t = 4) assuming a required rate of
      return = 10%?

        2. 1   2.1(1  0.05 ) 2.1(1  0.05 )2
                                               2.1(1  0.05 )   3
P0                                        
     1  0.10 (1  0.10 ) 2
                               (1  0.10 ) 3
                                                (1  0.10 ) 4




                                                                    40
    What drives growth ?

v   Most stock valuation models are based on the assumption
    that dividends grow over time.
v   What drives this growth ?
v   The two major drivers of growth are :
    a) Plough-back or Retention Ratio
    b) Return on Equity (ROE)
v   Growth = Retention Ratio x Return on Equity
v   Illustration:
    Omega limited has an equity (net worth) base of 100 at
    the beginning of year 1. It earns a ROE of 20 %. It pays
    out 40 % of its equity earnings and ploughs back 60 % of
    its equity earnings

                                                               41
    Financials of Omega Limited

                            Year 1      Year 2   Year 3
Beginning Equity
ROE
Equity Earnings
Dividend Payout Ratio

Dividends
Retention Ratio
Retained earnings

What is the growth Rate of Dividend ?                     42
    Financials of Omega Limited
                          Year 1      Year 2   Year 3
Beginning Equity           100         112     125.44
ROE                        20%         20%      20%
Equity Earnings             20         22.4     25.1
Dividend Payout Ratio      0.40        0.40     0.40
Dividends                   8          8.96    10.04
Retention Ratio            0.60        0.60     0.60
Retained earnings           12        13.44    15.06

Growth Rate = RE x ROE = 0.60 x 20 %= 12 %
                                                        43
What is this growth actually ?


Sustainable growth rate =ROE  Retention ratio


  Return on equity (ROE) = Net income / Equity
  Retention ratio = 1 – Payout ratio




                                                 44
     Estimation of Growth
v   The growth rate in dividends
    (g) can be estimated in a
    number of ways.

     Using      the    company’s
      historical average growth
      rate.
     Using an industry median or
      average growth rate.
     Using     the    sustainable
      growth rate.

                                     45
  Two Stage Growth Model

The simplest extension of the constant growth model
assumes that the extraordinary growth will continue for a
finite number of years and thereafter the normal growth
rate will prevail indefinitely.

      D1      D1 (1  g1 ) D1 (1  g1 ) 2           D1 (1  g1 ) n 1    Pn
P0                                      ......                    
     1  k c (1  k c ) 2   (1  k c ) 3             (1  k c ) n  (1  k c ) n
where, P0  current price of the equity share
        D1  dividend expected a year hence
        g1  extraordinary growth rate applicable for n years
        Pn  price of the equity share at the end of the year n

                                                                                    46
Two Stage Growth Model (contd….)



 The first term on the right hand side of above
 equation is the PV of a growing annuity, and
 its value is equal to:




                                                  47
Reminder: Present Value of a Growing annuity

If ,
A(1  g)  cash flow at the end of 1st year
A(1  g) 2  cash flow at the end of 2nd year
A(1  g) n  cash flow at the end of nth year


                                      (1  r)n  (1  g ) n 
PV of growing annuity  A(1  g)                            
                                        (r  g )(1  r)n 
This is true for g  r and g  r but not for g  r in the
case of which,PV shall be only nA.
                                                                 48
Two Stage Growth Model (contd….)

 The first term on the right hand side of above
 equation is the PV of a growing annuity, and its
 value is equal to:

                   1  g n 
                 1  
                      1 k 
                             1
                                
                           c  
              D1 
                      k c  g1 
                                
                 
                                
                                 

                                                    49
Two Stage Growth Model (contd….)

Hence,


          1 g         n
                              
        1  
             1 k 
                    1
                             
                  c             Pn
P0  D1                        
                               (1  k ) n
             k c  g1
                                     c

        
                             
                              
                                             50
   Two Stage Growth Model (contd….)

  Since the two-stage growth model assumes that the
  growth rate after n years remains constant at g2, Pn will be
  equal to:


                             D n 1
                       Pn 
                            kc  g2


where, D n 1  dividend for year (n  1)  D1 (1  g1 ) n 1 (1  g 2 )
         g 2  growth rate in the second period
                                                                           51
Two Stage Growth Model (contd….)

Substituting the above expressions, we have:


          1  g n 
              1  k    D (1  g ) n 1 (1  g ) 
        1        1
                      
                  c                                    1        
P0  D1                                                       
                            1       1            2
             k c  g1           k c  g1          (1  k ) n   
                                                        c      
        
                       
                        




                                                                        52
Example:

  The current dividend on an equity share of Vertigo
  Limited is Rs 2.00. Vertigo is expected to enjoy an
  above-normal growth rate of 20% for a period of 6
  years. Thereafter, the growth rate will fall and
  stabilize at 10%. Equity investors require a return of
  15 %. What is the intrinsic value of the equity share
  of Vertigo ?

g1 = 20 %, g2 = 10 %, n = 6 years, kc = 15%, D0 = Rs 2.00


                  Ans: Rs 79.597
                                                            53
Non-constant growth

v   Suppose a firm is expected to increase
    dividends by 20% in one year and by 15% in
    two years. After that dividends will increase
    at a rate of 5% per year indefinitely. If the last
    dividend was $1 and the required return is
    20%, what is the price of the stock?

v   Remember that we have to find the PV of all
    expected future dividends.

                                                         54
Non-constant growth – solution

v   Compute the dividends until growth levels off
     • D1 = 1(1.2) = $1.20
     • D2 = 1.20(1.15) = $1.38
     • D3 = 1.38(1.05) = $1.449
v   Find the expected future price (by using the final
    dividend calculation)
     • P2 = D3 / (k – g) = 1.449 / (.2 - .05) = 9.66
v   Find the present value of the expected future cash
    flows
     • P0 = 1.20 / (1.2) + (1.38 + 9.66) / (1.2)2 = 8.67


                                                           55
Non-constant growth

v   The Green Shoe Company’s last dividend
    paid (D0) was $1.00. Dividends are projected
    to grow at a rate of 7% per year for the next 2
    years, 5% per year for the 3rd year, and
    starting with year 4 they will grow at a
    constant rate of 4%, forever. If the required
    return on the stock is 12%, what is the price of
    the stock today?


                                                       56
Non-Constant Growth

v   At times, a new company may pay no dividends
    early in its life but start paying dividends that grow
    at a constant rate some time in the future.
v   At other times, a new company may pay small
    dividends initially and, at some point in the future,
    start paying dividends that grow at a constant rate.
v   However, as always, the value of the stock is the
    present value of all future dividends.
v   Many cash flow scenarios are possible in this
    situation.

                                                             57
   Non-Constant Growth

Example:
v ABC Company does not plan to pay a dividend
  until year 5. ABC’s expects the dividend in year
  five to be $1 and dividends in future years to grow
  at a constant rate of 5%. If the firm’s risk-adjusted
  required rate of return is 13%, what is the value of
  a share of stock in the company today?

    P4 = 1/(.13 – .05) = $12.50
    P0 = 12.50(1.13)-4 = $7.67
                                                      58
Components of Required Return
v   Thus far, the discount rate or required rate of return
    has been given to us.
v   Later chapters have more to say about this, but for
    now, using the dividend growth model, lets analysis
    the required rate of return:

        Rearranging:
              kc = r = D1/P0 + g

        where, D1/P0 = the dividend yield
               g = the capital gains yield

                                                             59
     Components of Required Return

v   Hence, Total Return on Common Stock has two
    components:
     • Dividend Yield
     • Capital Gains Yield.


       Return = Dividend Yield + Capital Gains Yield

                   D t Pt  Pt 1
                r       
                   Pt 1   Pt 1
                                                       60
   Illustration:

  We observe a stock selling for $ 20 per share. The next
  dividend will be $ 1 per share. You think that the dividend
  will grow by 10 % per year more or less indefinitely. What
  return does this stock offer you if this is correct ?

Return = Dividend Yield + Capital Gains Yield
     r=       D1/P0     +         g
       =       1 / 20   +         0.10
       =        0.05    +         0.10
       = 0.15
      i.e. 15 %
                                                            61
     Verification

    We can verify this answer by calculating the price in one year P1 , using
    15 % as the required return.

    P1   = D1 (1+g) / (r – g)
         = $ 1 x 1.10 / (0.15 -0.10)
         = $ 22

v   $ 22 is 10 % more than $ 20, so the stock price has grown by 10 %
v   If you buy the stock today in $ 20, it’ll pay $ 1 dividend at the end of the
    year, and you’ll gain $ 2 by selling it.
v   Dividend yield is thus $ 1 / 20 = 0.05 i.e. 5%
v   Capital gains yield is thus $ 2 /20 = 0.10 i.e. 10 %
v   So your Total return would be 5 % + 10 % = 15 %
                                                                                62
Impact of growth on Price, Returns and P/E Ratio

v   The expected growth rates of the companies differ
    widely.
v   Some are expected to remain virtually stagnant or
    grow slowly; others are expected to show normal
    growth; still others are expected to achieve
    supernormal growth rate.
v   Assuming a constant total required return,
    differing expected growth rates mean differing
    stock prices, dividend yields, capital gains yields,
    and P/E ratios.
                                                       63
   Illustration (contd….)

Consider three cases of growth rates:
            Low growth firm                    5%
           Normal growth firm                 10 %
            Supernormal growth firm           15%

  The expected earnings per share and dividend per share of
  each of the three firms are Rs 3.00 and Rs 2.00 respectively.
  Investor’s required total return from equity investments is
  20%.

  Given the above information, calculate the stock price,
  dividend yield, capital gains yield, and P/E ratio for the
  three cases
                                                              64
    Illustration (contd…)

                 Price        Dividend Yield     Capital     P/E Ratio
            P0 = D1 / (r – g)     (D1/P0)      Gains Yield    P0/EPS
                                                (P1-P0)/P0

  Low
 Growth
  Firm

 Normal
 Growth
  Firm

Supernorm
al Growth
   Firm
                                                                         65
    Illustration (contd…)

                 Price        Dividend Yield     Capital     P/E Ratio
            P0 = D1 / (r – g)     (D1/P0)      Gains Yield    P0/EPS
                                                (P1-P0)/P0
  Low          13.33             15 %             5%          4.44
 Growth
  Firm
 Normal        20.00             10 %            10 %         6.67
 Growth
  Firm
Supernorm      40.00             5%              15 %         13.33
al Growth
   Firm

                                                                         66
     Inference

v   As the expected growth in dividend, increases, other
    things remaining constant, the expected return
    depends more on capital gains yield and less on the
    dividend yield.
v   As the expected growth rate in dividend increases,
    other things remaining constant, the P/E ratio
    increases.
v   High dividend yield and low P/E ratio imply limited
    growth prospects.
v   Low dividend yield and high P/E ratio imply
    considerable growth prospects.                       67
Valuation of Common Stock

   Price Ratio Approach




                            68
Price Ratio Analysis

v   Price-earnings ratio (P/E ratio)
     • Current stock price divided by annual earnings
       per share (EPS).
v   Earnings yield
     • Inverse of the P/E ratio: earnings divided by price
       (E/P).
v   High-P/E stocks are often referred to as growth
    stocks, while low-P/E stocks are often referred to as
    value stocks.


                                                             69
Price Ratio Analysis

v   Price-cash flow ratio (P/CF ratio)
     • Current stock price divided by current cash flow
       per share.
     • In this context, cash flow is usually taken to be net
       income plus depreciation.
v   Most analysts agree that in examining a company’s
    financial performance, cash flow can be more
    informative than net income.
v   Earnings and cash flows that are far from each other
    may be a signal of poor quality earnings.


                                                               70
Price Ratio Analysis

v   Price-sales ratio (P/S ratio)
     • Current stock price divided by annual sales per
       share.
     • A high P/S ratio suggests high sales growth,
       while a low P/S ratio suggests sluggish sales
       growth.
v   Price-book ratio (P/B ratio)
     • Market value of a company’s common stock
       divided by its book (accounting) value of equity.
     • A ratio bigger than 1.0 indicates that the firm is
       creating value for its stockholders.
                                                            71
Price Ratio Analysis

Intel Corp (INTC) - Earnings (P/E) Analysis
    Current EPS                $1.35
    5-year average P/E ratio    30.4
    EPS growth rate            16.5%
  expected = historical  projected EPS
 stock price   P/E ratio
             = 30.4       ($1.351.165)
             = $47.81

                                              72
Price Ratio Analysis

Intel Corp (INTC) - Cash Flow (P/CF) Analysis
      Current CFPS              $1.97
      5-year average P/CF ratio 21.6
      CFPS growth rate          15.3%
  expected = historical  projected CFPS
 stock price   P/CF ratio
             = 21.6        ($1.971.153)
             = $49.06

                                                73
Price Ratio Analysis

 Intel Corp (INTC) - Sales (P/S) Analysis
    Current SPS                 $4.56
    5-year average P/S ratio     6.7
    SPS growth rate            13.3%
  expected = historical  projected SPS
 stock price   P/S ratio
             =    6.7     ($4.561.133)
             = $34.62

                                            74
P/E Ratio Approach

                      P0
            P0  E1 
                      E1
    where, P0  Estimated Price
          E1  Estimated EPS
          P0
              Justified P/E Ratio
          E1
                                     75
    Determinants of P/E Ratio

According to Constant Growth Dividend Discount Model

      D1        E1 (1  b)
P0         
     r - g r  ROE  b
P0        (1  b)
   
E1 r  ROE  b


where, b  ploughback or retention ratio
                                                   76
Determinants of P/E Ratio

Factors that determine the P/E ratio are:

1.   The dividend payout ratio, (1-b)
2.   The required rate or return, r
     a) Interest Rate
     b) Risk
3.   The expected growth rate, g = ROE x b




                                             77

				
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