Stock Valuation PDF

Stock Valuation Learning Goals Know the different kinds of stocks Know the different kinds of preference shares Learn the non-discounted method in valuing stocks Learn the discounted method in valuing stocks Understand how the stock price fluctuates Differentiate bullish and bearish mar...

Stock Valuation Learning Goals Know the different kinds of stocks Know the different kinds of preference shares Learn the non-discounted method in valuing stocks Learn the discounted method in valuing stocks Understand how the stock price fluctuates Differentiate bullish and bearish market Bonds vs Stocks Bonds vs Stock: Bonds Stocks Cash flows Interest Dividends May or may not Regularity of be made Every period cash flows regularly Creditor / Part-owner / Investor Shareholder Bondholder Different kinds of stocks Ordinary and Preference: Ordinary Preference Yes, but with priority in Claim over assets Yes distribution during liquidation Yes, but depends on the Claim over earnings Yes, but with priority in plan distribution of distribution (dividend) dividend distribution preference shares Voting rights (influence/control over Yes No corporate actions) Different kinds of preference shares Kinds of Preference Shares 1) Cumulative - shares that entitle the holder to current and past dividends (in arrears). 2) Non-cumulative - shares that entitle the holder only to current dividends. Kinds of Preference Shares 3) Participating - shares that entitle the holder to surplus profits after the provision of the basic dividend to all classes of shares. 4) Non-participating - shares that entitle the holder only to basic dividend. Kinds of Preference Shares 5) Redeemable - shares that grant the issuing company the right or power to redeem, purchase or “buy back” the shares after a certain period. 6) Convertible - shares that can be converted into another class of shares.  Question: Why do we need to study stock valuation?  Answer: It would be advantageous for the investors to be able to estimate properly a stock’s true (intrinsic) value. By comparing the intrinsic value with its current price in the stock market, the investor can be guided accordingly with his decision to buy or sell a share of stock.  Guide: Intrinsic value > Stock price = Buy (undervalued) Intrinsic value < Stock price = Sell (overvalued) Stock Valuation Non-discounted Technique 1) Book Value or Net Asset Value (NAV) approach - utilizes the total shareholders’ equity portion of the FS. - objective is to determine the Net Asset Value per Share or the Book Value per Share which represents the equity or the value of each ordinary share. - it is also the amount that would be paid on each share assuming that the company is liquidated. Formula: = Total Shareholders’ Equity / number of ordinary shares Non-discounted Technique 1) Book Value or Net Asset Value (NAV) approach = Total Shareholders’ Equity divided by No. of outstanding shares (useful for single class of shares) = (Total SHE – Total equity attributable to preference shares) divided by number of outstanding common shares (useful if there are other classes other than ordinary shares) Non-discounted Technique 1) Book Value or Net Asset Value (NAV) approach – single class Mcdollibee Company has the following information derived from its most recent audited financial statements: Total assets P25,000,000 Total liabilities 10,000,000 No. of ordinary shares (issued & outstanding) 1,000,000 shares Determine the NAVPS or BVPS: Non-discounted Technique 1) Book Value or Net Asset Value (NAV) approach – single class Mcdollibee Company has the following information derived from its most recent audited financial statements: Total assets P25,000,000 Total liabilities 10,000,000 No. of ordinary shares (issued & outstanding) 1,000,000 shares Determine the NAVPS or BVPS: Answer: P15 per share Non-discounted Technique 1) Book Value or Net Asset Value (NAV) approach - w/ pref. shares SEC Company has the following information derived from its most recent audited financial statements: Total assets P25,000,000 Total liabilities 10,000,000 Total equity attributable to preference shares 2,500,000 No. of ordinary shares (issued & outstanding) 1,000,000 shares No. of preference shares 600,000 shares Determine the NAVPS or BVPS: Non-discounted Technique 1) Book Value or Net Asset Value (NAV) approach - w/ pref. shares SEC Company has the following information derived from its most recent audited financial statements: Total assets P25,000,000 Total liabilities 10,000,000 Total equity attributable to preference shares 2,500,000 No. of ordinary shares (issued & outstanding) 1,000,000 shares No. of preference shares 600,000 shares Determine the NAVPS or BVPS: Answer: P12.50 per share Discounted Technique 1) Discounted Dividend Model - this takes into consideration the expected cash flows of investment in stocks which are dividends and stock price upon sale. - Simply put, the value of the stock depends on the present value of all the dividends and the price of the stock once it is sold. - This model primarily relies on the proper estimation of a stock’s growth rate which is one of the key features of this valuation method. Discounted Technique 1) Discounted Dividend Model (continuation) - this model assumes that dividends grow in three possible ways namely a) Zero or no growth stocks b) Constant growth stocks c) Non-constant growth stocks Discounted Dividend Model a) Zero or No Growth Stocks - a situation where a stock and its dividends do not grow. - under this assumption, dividends today is equal to future dividends. Formula: P=D/r Stock Price = Dividend divided by rate of return Discounted Dividend Model a) Zero or No Growth Stocks RF Hotels Corporation has paid P5.00 dividends last year to its stockholders. The company expects that this dividend will not grow in its succeeding years of operation. The shareholders expect a 10% return on RF’s stock. Determine the stock price of RF Hotels Corporation. Discounted Dividend Model a) Zero or No Growth Stocks RF Hotels Corporation has paid P5.00 dividends last year to its stockholders. The company expects that this dividend will not grow in its succeeding years of operation. The shareholders expect a 10% return on RF’s stock. Determine the stock price of RF Hotels Corporation. Answer: P = D / r = P5.00 / 10% = P50.00 Discounted Dividend Model b) Constant Growth Stocks - a situation where a stock and its dividends grow at a constant rate throughout its life. - this exhibits a kind of growth rate that does not change during the life of such stock. Formula: P = D / (r – g) Stock Price = Dividend divided by (rate of return less growth rate) *Dividend must be the dividend at the end of the period. **growth rate must always be less than the required rate of return) Discounted Dividend Model b) Constant Growth Stocks NN Corp. is expected to declare a P7.00 dividend at the end of the year. Similar stocks return 16%. NN’s stock is expected to grow at a rate of 6% annually for the rest of the stock’s life. Determine the stock price of NN Corp. Discounted Dividend Model b) Constant Growth Stocks NN Corp. is expected to declare a P7.00 dividend at the end of the year. Similar stocks return 16%. NN’s stock is expected to grow at a rate of 6% annually for the rest of the stock’s life. Determine the stock price of NN Corp. Answer: P = D / (r – g) = P7.00 / (16% - 6%) = P70.00 Discounted Dividend Model c) Non-Constant Growth Stocks - a situation where a stock and its dividends grow at a different rate at the earlier part of its life. Such growth shall terminate at a horizon or terminal date (TD) where the stock and its dividends begin to grow at a constant rate. Formula: P = Sum of all Present value of dividend per year + Present value of terminal value on terminal date *Terminal Value – computed similarly to a constant growth stocks in which the dividends in the constant growth phase of the stock is collected and discounted to the terminal date. Discounted Dividend Model c) Non-Constant Growth Stocks AA Industries Inc. expects to pay a P3.00 per share dividend to its common stockholders at the end of the year. The dividend is expected to grow 25% a year until the end of the third year, after which time the dividends is expected to grow at a constant rate of 5% a year. AA Industries’ shareholders require at 12% return on this stock. Determine AA Industries Inc.’s stock price. Discounted Dividend Model c) Non-Constant Growth Stocks AA Industries Inc. expects to pay a P3.00 per share dividend to its common stockholders at the end of the year. The dividend is expected to grow 25% a year until the end of the third year, after which time the dividends is expected to grow at a constant rate of 5% a year. AA Industries’ shareholders require at 12% return on this stock. Determine AA Industries Inc.’s stock price. Answer: P59.05 (solution to be added on the next slide) Discounted Dividend Model c) Non-Constant Growth Stocks Price Fluctuations of Stocks - Like any other product, the price of shares hinges on supply and demand. Prices rise when the supply of shares for purchase is not enough to meet the demand of investors; they fall when fewer investors are interested in buying shares. Bullish and Bearish Market - A bullish market is when stock prices are on the rise and economically sound - A bearish market is when prices are in decline.