MAF 203 Topic 5 SHARE VALUATION chapter 9

Transcription

1 MAF 23 Tpic 5 SHARE VALUATION chapter 9 Valuatin: Overview When we value any asset in finance, we fllw 3 simple steps: 1) Estimate the future cash flws generated by the asset. 2) Find and apprpriate required rate f return (See Tpic 3) 3) Find the present value f each f the future cash flws using the apprpriate required rate f return. 4) Add all the present values f all the future cash flws tgether. Learning Objectives: Share Valuatin 1. Describe the types f shares (equity securities). 2. Describe hw the general dividend discunt mdel values a share. 3. Discuss the assumptins f the general dividend discunt mdel. 4. Emply the general dividend discunt mdel t value a cmpany s rdinary shares. 5. Describe hw the Price-Earnings mdel values a share. 6. Emply the Price-Earnings mdel t value rdinary s shares. 7. Discuss challenges in share valuatin cmpared t bnd valuatin. Valuatin f Shares (Equity) Three Mdels f Share Valuatin: ü Dividend Valuatin Mdel ü Price-Earnings Mdel X Capital Asset Pricing Mdel (CAPM) (cvered in Tpic 3)

2 Types f equity securities Share valuatin with Dividend Valuatin Mdel The peridic cash flws frm an investment in shares are dividends. Assuming the dividends cntinue indefinitely, the value f the share ( ) is: This equatin des nt ignre the capital gains, as the price a share is sld fr at time n shuld represent the discunted value f dividends beynd time n. Share valuatin with Dividend Valuatin Mdel We estimate the value f a share using the same principles as any ther asset. 1) Estimate the future cash flws (dividends) generated by the asset. 2) Find and apprpriate required rate f return. 3) Find the present value f each f the future cash dividends and terminal value using the required rate f return. 4) Add all the present values f all the future cash flws tgether The general expressin fr the value f a share: Price f a share is present value f all expected future dividends (assuming share is a perpetuity) The fllwing frmula (9.1 n p. 312) des nt assume any specific pattern fr future cash dividends, such as a cnstant grwth rate

3 Share valuatin: Three Mdels Three different assumptins can cver mst grwth patterns. The fllwing mdels are based n alternative assumptins fr the future cash flws. 1. Cnstant Dividend Mdel: Dividend payments are expected t remain cnstant ver time frever. (e.g: The dividend payment is expected t be $5 frever). 2. Cnstant Grwth: Dividends are expected t have cnstant grwth rate frever. (e.g: Dividends are expected t grw at 5% each year frever). 3. Nn-cnstant Grwth: Dividends are expected grw at different grwth rates during different time spans. (e.g 5% fr the first 5 years and 2% after that). Fr valuatin purpses we als assume that shares are held frever by an investr. Further we assume that the required rate f return des nt change fr the duratin we are valuing the asset. Cnstant dividend mdel/zer Grwth The dividend payment pattern remains cnstant ver time: D1 = D2 = D3 =... = D PRICE=P $5 $5 $5 $5 $5 $5 $5 $5 $5 Till Infinity In this case the dividend-discunt mdel becmes: = D (1+ R) + D (1+ R) + D 2 (1+ R) + D 2 (1+ R) the present value f a perpetuity with a cnstant cash flw is CF, where CF is the cnstant cash flw and i is i the interest rate. The valuatin mdel fr a zer grwth share: (Frmula 9.2 n p 314) = D R P is the price f the share tday, D is the cnstant dividend and R is the required rate f return r discunt rate (i). This mdel can be used fr irredeemable(infinite life) preference shares with equal dividend payments! Lk at tutrial questins. Preference Shares Preference shares are similar t bnds in that preference sharehlders receive a fixed dividend which must be paid befre dividends can be paid n rdinary shares. Dividend Valuatin Mdel Zer Grwth Preference shares have a cnstant dividend int perpetuity, with n grwth in dividends. Therefre, the value f a preference share is fund in the same way as the value f a perpetuity: = D R

4 Cnstant grwth dividend mdel PRICE=P D=5 D1=(1+g) D2=(1+g) 2 D2=(1+g) 3 D2=(1+g) 2 D2=(1+g) 2 D2=(1+g) 2 D2=(1+g) 2 D2=(1+g) 2 Till Infinity EACH YEAR THE DIVIDEND GROWS BY g% - Cash dividends d nt remain cnstant but instead grw at sme average rate g frm ne perid t the next and that grwth rate remains cnstant frever - Cnstant dividend grwth may be an apprpriate assumptin fr mature cmpanies with a histry f stable grwth - Recall that equatin fr a grwing perpetuity is: (Tpic 2) - Hw t value a cnstant grwth share: PVA = CF1/(i g) P 3 = D 3(1 + g) R g = D 7 R g (9.3 and 9.4) Cnstant grwth dividend mdel: Example - X Limited has just paid a dividend f $.25 per share and the dividends are expected t grw at a cnstant rate f 3% per annum. If the required rate f return is 9.5%, calculate the expected market price (in fact, value ) per share. - Always use the next dividend. - If the current market price f the share is $4.25, what wuld be yur cnclusin and the decisin? Calculating future share values - The cnstant-grwth dividend mdel can be mdified t determine value f a share at any pint in time - The fllwing equatin shws value f a share at any time t as fllws: (Frmula 9.5 n p. 318) Pt = Dt + 1 (R - g) Calculating Future Share Values: Example ABC Cmpany has a current dividend f $2.5 per share. Investrs require a 15% rate f return and the firm has frecasted dividends will grw at 5% p.a frever. What will the share price be in 5 years time? Step 1: Draw a timeline STEP 2: Calculate D6 (Dt+1) D6=D(1+g) 6 =2.5(1+.5) 6 =$3.35 STEP 3: Cmpute future value.

5 P5 BCD = E.EF =$ FC3.3F Share Price Sensitivity T The Dividend Grwth Rate (g) The higher is the grwth rate in dividends, g, the higher will be the share price. Why? 1. In terms f the cnstant grwth in dividends pricing frmula, the higher is g the lwer will be the denminatr (R g) and, therefre, with a fixed numeratr (D 1 ) the result (, ) must be higher: = 2. It als makes intuitive sense. If g is higher then future dividends will be higher s, therefre, mre investrs will want the share in rder t get hld f the higher future dividends. Therefre, demand fr the share will g up, and with a fixed supply f the share, the price f the share must rise. Share Price Sensitivity T The Required Rate f Return, R The higher is the required rate f return n equity, r e, the lwer will be the share price. Why? 1. In terms f the cnstant grwth in dividends pricing frmula, the higher is r e the higher will be the denminatr (r e g) and, therefre, with a fixed numeratr (D 1 ) the result (, ) must be lwer: = D 1 (R - g) D 1 (R - g) 2. It als makes intuitive sense. If r e is higher then investrs require a higher rate f return n their investment. Therefre, hlding ther factrs cnstant, t get a higher return they must pay a lwer price (remember, there is an inverse relatinship between the price f an asset and the rate f return n the asset: lwer price -à higher return; higher price---à lwer return). Nn-Cnstant (supernrmal) grwth dividend mdel - During the early part f their lives, very successful cmpanies experience a supernrmal rate f grwth in earnings. - T value a share f a cmpany with supernrmal dividend grwth patterns, we can apply a cmbinatin f tw dividend mdels: - First, we discunt the knwn dividends during the high grwth perid/s individually. - Secnd, we use the cnstant grwth dividend mdel at the pint in time the grwth becmes cnstant and stable. Nn-Cnstant (supernrmal) grwth dividend mdel: Example A cmpany s dividends will grw at 5% per year fr the first 3 years. Thereafter the dividends will grw at 3% per year frever. The required rate f return is 15% and a dividend f $1. was paid last year. STEP 1: DRAW TIMELINE STEP 2: CALCULATE THE VALUE OF DIVIDENDS DURING 1st GROWTH PHASE and 1 year after that. D=$1. (Frm questin)

6 D1=D (1+g1)=1 (1+.5)=$1.5 D2=D1 (1+g1)=1.5 (1+.5)=$1.125 D3=D2 (1+g1)=1.125 (1+.5)=$ D4=D3 (1+g2)= (1+.3)=$ STEP 4: CALCULATE THE PRESENT VALUES(PV) OF FUTURE DIVIDENDS AND ADD THEM. D = 1 (1+ R) + D 2 (1+ R) + + D t P + t 2 (1+ R) t (1+ R) t D1=$1.5 D2=$1.125 D3=$ P3=$ P = P = Price-Earnings Mdel = =$9.46 The Price/Earnings Mdel (P/E Mdel) is anther methd used t estimate the firm s share price. With the P/E Mdel the share price is calculated by multiplying the firm s expected earnings per share (EPS) by the firm s P/E rati (althugh, ften the average P/E rati fr the particular industry is used). The P/E rati reflects the amunt investrs are willing t pay fr each dllar f earnings. With the P/E Mdel share price P 3 = EPS x P/E. What determines a firm s P/E rati?

7 1. Risk - The riskier the investment the lwer will the P/E rati. Why? Because the riskier the investment the higher will be the investrs required rate f return. Therefre, t receive a higher rate f return investrs will nly be willing t pay a lwer price. The lwer the price the lwer the P/E rati. 2. Grwth f earnings The greater the grwth rate in the cmpany s earnings the higher will be the P/E rati. Why? The higher are future earnings the higher will be the demand fr the share, and with a fixed supply, the price f the share will rise. The higher the price f the share the higher the P/E rati. Calculating The P/E rati The frmula t calculate the price/earnings rati is: (1 - b) P / E = R - g where: b = percentage f earnings per share retained by the firm, i.e. retentin rati. R = the required rate f return f the firm s sharehlders; and g = the lng-term cnstant grwth rate f earnings per share. Example Argyle Mines Pty. Ltd. will retain 4% f its expected earnings per share f $.15. If Argyle s earnings per share are t grw at 2% p.a. int perpetuity and the required rate f return f it s equity hlders is 7% p.a. what is Argyle s: a. P/E rati? (1 -.4) P / E = (.7 -.2).6 P / E =.5 P / E = 12 b. Share price? P = P / Ex( EPS) P = 12x($.15) P = $1.8 Real-Wrld Example frm au.finance.cm ü TLS.AX shares appear t be slightly undervalued.

8 Price-Earnings Mdel : Example The directrs f Parmalat Pty. Ltd. have prvided yu, the Crprate Finance Manager, with the fllwing infrmatin: Expected earnings per share $1.5 Sharehlders required return 11% p.a. Earnings per share t be retained by the firm 6% Grwth rate in earnings per share 5% p.a. Required: a. Calculate Parmalat s P/E rati. In simple terms, what des this rati tell yu? b. Calculate Parmalat s share price using the P/E rati calculated in Part a. a. P/E Rati (1 -.6) P / E = (.11-.5) P / E P / E.4 =.6 = 6.67 This P/E rati f 6.67 tells us that the equity investrs f Parmalat are prepared t pay $6.67 per $1 f earnings n each Parmalat share. b. Shareprice P = P / Ex( EPS ) P P = 6.67x($1.5) = $1. With 1% certainty, can we estimate the market price f a share using a frmula? N n n n - Why? - Future cash flws cannt be knwn with 1% certainty. Cash flws are affected by varius firmspecific and market-wide factrs. - Discunt rate (Required rate f return) may vary frm investr t investr. - Price is ultimately decided by the market (supply and demand fr the particular share) Hw is this tpic relevant? Finance Manager s pint f view: Their purpse is t maximise the value f firm(remember frm Tpic 1) Value f Firm= Value f Equity+ Value f Debt Value f a Firm=Sum f PV(Net Cash flws frm debt)+sum f PV(Net cash flws frm equity) Or Value f a Firm=P/E rati *EPS S far we learnt hw we calculate the value f shares and value f bnds frm the investr s pint f view. We have t understand hw t value shares and bnds because the firm s value is dependant n each cmpnent s value.