Chapter 6. Topics Covered. Preferred Stock Characteristics

Transcription

1 Chapter 6 Valuing Stocks Topics Covered referred Stocks and their valuation Valuing Common Stocks Simplifying the Dividend Discount Model No growth Constant growth Non-constant growth Growth Stocks and Income Stocks referred Stock Characteristics Unlike common stock, no ownership interest Second to debt holders on claim on company s assets in the event of bankruptcy. Annual dividend yield as a percentage of par value referred dividends must be paid before common dividends If cumulative preferred, all missed past dividends must be paid before common dividends can be paid.

2 referred Stock Valuation romises to pay the same dividend year after year forever, never matures. A perpetuity. = Div/r Expected Return: r = Div/ Example: GM preferred stock has a $25 par value with a 8% dividend yield. What price would you pay if your required return is 9%? The Financial ages: referred Stocks 52 weeks Yld Vol Hi Lo Sym Div % E s Close GM pfg Dividend: $2.28 on $25 par value = 9.2% dividend rate. Expected return: 2.28 / 27. = 8.4%. What do investors in common stock want? eriodic cash flows: dividends, and To sell the stock in the future at a higher price Management to maximize their wealth 2

3 Valuing Common Stocks: Expected Return Expected Return - The percentage yield that an investor forecasts from a specific investment over a set period of time. Sometimes called the holding period return (HR). Expected Return = r = Div+ Expected Return The formula can be broken into two parts. Dividend Yield + Capital Appreciation Div Expected Return = r = + Example Lisa Simpson buys Grease Gougers stock for $2 per share. In a year she expects the receive $ in dividends and the price of the stock to be $22. What is Lisa s expected return? 3

4 Valuing Common Stocks Dividend Discount Model - Computation of today s stock price which states that share value equals the present value of all expected future dividends. = Div Div2 DivH H ( + r) ( + r) ( + r) H H - Time horizon for your investment. Stock Valuation Infinite Holding eriods Stock Value = V of Future Expected Dividends = D + D ( + r) ( + r) ( + r) ( + r) D 3 D Stock Valuation: Dividend atterns For Valuation: we will assume stocks fall into one of the following dividend growth patterns. Constant growth rate in dividends Zero growth rate in dividends, like preferred stock Supernormal (non-constant) growth rate in dividends 4

5 Stock Valuation Case Study: Doh! Doughnuts We have found the following information for Doh! Doughnuts: current dividend = $2 = Div Required return = 2% = r Analysts Estimates for Doh! Doughnuts NEDFlanders predicts a constant annual growth rate in dividends and earnings of zero percent (%) Barton Kruston Simpson predicts a constant annual growth rate in dividends and earnings of 7 percent (7%). Homer Co. expects a dramatic growth phase of 2% annually for each of the next 3 years followed by a constant 7% growth rate in year 4 and beyond. Our Task: Valuation Estimates What should be each analyst s estimated value of Doh! Doughnuts? 5

6 Valuing Common Stocks: No Growth If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a ERETUITY. Div erpetuity = or ES = r r Assumes all earnings are paid to shareholders. Ned Flanders Valuation Div = $2, r = 2% or.2, g = % = Div /r = $2/.2 = $6.67 Valuing Common Stocks: Constant Growth Constant Growth DDM - A version of the dividend growth model in which dividends grow at a constant rate (Gordon Growth Model). Div Div (+ g) = r - g r - g = 6

7 Barton Kruston Simpson s Valuation Div = $2, g = 7%, r = 2% Expected Return of Constant Growth Stocks Expected Rate of Return = Expected Dividend Yield + Expected Capital Gains Yield Div / = Expected Dividend Yield g = Expected Capital Gains Yield R = Div / + g = Div (+g)/ + g Example Burns International s stock sells for $4 and their expected dividend is $4. The market expects a return of 4%. What constant growth rate is the market expecting for Burns International? 7

8 Homer Co. Valuation Supernormal (non-constant) growth Years -3 expect 2% growth After year 3: constant growth of 7% Non-constant Growth Stock Valuation Framework: Assume Stock has period of non-constant growth in dividends and earnings and then eventually settles into a normal constant growth pattern (g n ). g g 2 2 g 3 3 g n 4 g n 5 g n... D D 2 D 3 Nonc-onstant Growth eriod Constant Growth Non-constant Growth Valuation rocess 3 Step rocess Estimate Dividends during non-constant growth period. Estimate rice, which is the V of the constant growth dividends, at the end of non-constant growth period which is also the beginning of the constant growth period. Find the V of non-constant dividends and constant growth price. The total of these Vs = Today s estimated stock value. 8

9 Back to Homer Co s Valuation: Step Homer Co s Valuation: Step 2 Homer Co s Valuation: Step 3 9