Common Stock...

8/22/2019 Common Stock Valuationaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa

http:///reader/full/common-stock-valuationaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa 1/41

CommonStock

Valuation

Group 8:Calleja, Walinsundin, Malaza,Bagtas, Ganias



What are STOCKS?

The number of stocks you acquire will determinehow big or small your ownership is. As youacquire more stocks, your ownership stake in the

company becomes greater.

Other terms for stocks are shares orequities.

In Filipino, stocks are called sapi, which meansto join or to partake.



What are STOCKS?

Stocks are shares of ownership in a company.When you buy stocks of a publicly listedcompany, you become a stockholder or

shareholder of a company. In other words, youbecome a part-owner of that company.

As a part-owner, you participate in the

companys growth and future profits. Conversely,you may also lose if the company suffers a lossor performs below market expectations.



Types of STOCKS:a. Common stock

It is a security usually purchased for participation inthe profits and control of ownership and management

of the company. A common stockholder exercisescontrol through voting rights during annual or specialstockholders meetings, but can only claim rights tothe companys assets and earnings when preferredshareholders are already paid in full.

Most of the issues traded in the local stock market arecommon stocks.

Common stocks are also known as ordinary shares.



Types of STOCKS:b. Preferred stock

It is a security whereby the holder has a higher claim onthe assets and earnings of the company.

In terms of dividend payment and liquidation, preferredshareholders have priority over common shareholders.Though preferred stockholders do not have voting rights,they are entitled to receive dividends before anydividends are paid to the common stockholders.

Preferred stocks usually have a specified limited rate of

return or dividend and a specified limited redemption andliquidation price.

Preferred stocks are also known as preference shares.



Foc

using

on

COMMON

STOCKS



Common Stock Features and

Characteristics:Par value

legal value of the share of stock

Dividends

Stockholders are given by the corporation with dividends orearnings. However, the corporation has no legal obligation topay dividends.

Maturity

Perpetual or no specific maturity date

Control over the firm

Owners of stocks have the voting rights to elect its directorswho in turn elect the officers to manage the business.



Common Stock Features and

Characteristics:

Priority to assets and earnings

Stockholders can only be paid after the interest on debt and

the preferred has been paid.

Preemptive rights

Stockholders have the right to purchase on a pro rata basisthe new issues of common stock

Represents ownership

Stocks are perpetual investments that represent equity

Income generating

Stocks are variable income securities.



How to start investing in STOCKS?

1. Choose your STOCKBROKER.

2. Open a TRADING ACCOUNT with your chosen

stockbroker.

3. Discuss with your stockbroker the stocks you wishto BUY or SELL.

4. Give ORDERS to the stockbrokers.

5. Get the CONFIRMATION RECEIPT.

6. Deliver/Pay before SETTLEMENT DATE.

7. Receive PAYMENT.


http:///reader/full/common-stock-valuationaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa 10/41

How Do You Make Your Money Grow inStocks:

1. Capital Gain or through an increase in stock price or capitalappreciation.

Capital appreciation is an increase in the market price of your stock. It is thedifference between the amount you paid when buying shares and the currentmarket price of the stock. However, if the company does not perform as

expected, the stock price may go down below your purchase price.

You cannot really earn from stock price appreciation unless you sell yourshares. Otherwise it is only a book value gain, which means it is not yetconverted to cash, and current price may change depending on market forces.

For example, if you buy a share of stock at Php100.00, and it rises toPhp110.00, your capital appreciation or gain is Php10.00. Keep in mind that

you only realize your gain of Php10.00 minus applicable charges, if you sell atPhp110.00. If you choose to hold it and it further increases to Php150.00, yourcapital gain would be Php50.00. However, if your stock decreases toPhp100.00, and you decide to sell it at that price, then your capital gain iszero.



How Do You Make Your Money Grow in Stocks:

2. Dividends declared by the company

Dividends are paid out to shareholders, representing earnings ofthe company that are not going to be reinvested in their business.There are two types of dividends: cash and stock dividends.

A cash dividend represents earnings declared by the company forevery share of stock. So, if the company declares a dividend of 25centavos per share, a stockholder with 10,000 shares will receive acash dividend of (Php2,500.00 minus tax of 10% for individualFilipino investors)(Php0.25 x 10,000) in cash.

Stock dividends are additional shares given to shareholders at nocost. If the company declares a 25 percent stock dividend, astockholder with 10,000 shares will be entitled to an additional2,500 shares of stock. These shares can be sold any time after theshares have been issued.



STOCK PRICE vs. INTRINSICVALUE



STOCK PRICE vs. INTRINSICVALUE

Stock priceIs simply the current market priceIt is easily observed for publicly tradedcompanies

Intrinsic valueRepresents the true value of the companysstockIt cannot be directly observed and instead beestimated

Important Note to Remember:If the stock market is reasonably efficient,

gaps between the stock price and intrinsic



Why do investors and companies care about

intrinsic value?

When investing in common stocks, ones goal is topurchase stocks that are undervalued (price is below

intrinsic value) and avoid stocks that are overvalued.

Investing into stocks should not only be based onperceived value which may lead to uncertainty of

returns but must be based on true value whichestimates how beneficial the investment is.



Common Stock Valuation: Understanding How

Stocks Are ValuedThe goal of stock valuation is to determine the

intrinsic value of a company (in other words, thecompanys fundamental economic value). If themarket price of the companys stock is greater thanthe companys intrinsic value, the investor shouldsell the stock. If the market price of the companysstock is less than the companys intrinsic value, theinvestor should buy the stock.

Determining a companys intrinsic value is oneof the most challenging responsibilities that aninvestor has.



Common Stock Valuation

Discounted Dividend Model

Price per Earnings Ratio

The Corporate Valuation Model



A. The Dividend Discount ModelAssumes that the value of a share of common stock is thepresent value of all future dividends.

The intrinsic value can be determined by these formulation:

P =

where: P = estimated price (intrinsic value) of the stock

k = the required rate of return of the stock, or the cost ofcapital



A. The Dividend Discount Model

Constant Growth StocksWith a constant growth rate g, P canbe shown to be:




EXAMPLE:Suppose for example that a stock has a cost of capital of20%, given its risk class. The analyst expects the stock topay a cash dividend of P0.75 per share and estimates thestocks price to be P18.75 at the end of the period.

P =

P =

P = 16.25




EXAMPLE:Suppose dividends in the previous exampleare expected to increase at 17% per year,then the stocks price can be estimated as:




Try this!Suppose for example that a stock has a cost of capital of20%, given its risk class. The analyst expects the stock topay a cash dividend of P1.65 per share and estimates thestocks price to be P19.35 at the end of the period.

P =

P =

P = 17.50




Suppose dividends in the previous example areexpected to increase at 12% per year, then thestocks price can be estimated as:



B. The Price Earnings Ratio (PER)

The theoretical ratio of price (intrinsic value) tonext periods Earnings per share is:

where:

b = the constant payout ratio or percentage

k = required rate of return

g = expected growth




Looks at the relationship between a stockprice and companys earnings

Other things held equal, higher growth firmswill have higher PE ratios than lower growthfirms.

Other things held equal, higher risk firms willhave lower PE ratios than lower risk firms

Other things held equal, firms with lowerreinvestment needs will have higher PE ratiosthan firms with higher reinvestment rates.




Thus, this model implies that the P/E ratio isdetermined by

1. The expected dividend payout ratio(dividends divided by earnings)

2. The estimated required return on the stock(k)

3. The expected growth rate of dividends forthe stock (g)




The theoretical ratio of price if there is no earnings growth:

g = qr = (1 payout ratio) ROE

PER =

where: r = rate of return (ROE)

q = earnings retention or reinvestment rate [ 1 payout ratio(b) ]

k = required rate of return, cost of capital




EXAMPLE:

What ROE for new investments would justify a PERof 25 for a stock whose cost of capital is 20% andwhose earnings retention rate is 80%? The model

gives us the result that expected ROE should be24%:

25 =

*Trial and Error




Try this!

Assume a stock has an expected dividend payoutof 50%, a required return of 12%, and an expecteddividend growth rate of 8%, this would imply thatthe stocks P/E ratio should be:



C. The Valuation Model

The determination of the economic value ofa stock is based on principles and conceptswhich lie at the core of finance.

These concepts define a financial asset,such as a common stock, as a claim on thecompanys future income or earnings.




The value of the claim depends on the expectedlevel and timing of future income or earnings, thecertainty that such earnings will be realized, and

the comparable returns the investor could haveearned by buying some other claim of similar risk(opportunity cost).

In the language of finance, the intrinsic value of astock is the present value of the future earningsof the stock, discounted at the stocks requiredrate of return, or cost of capital.




Stocks are risky investments and investorsexpect to be compensated for that risk.

The return that investors require given therisk of the financial asset is referred to asthe cost of capital or discount rate.

If investors find that their expected rate of

return is low given that the risk of the stockis high, they will avoid the stock or sell it ifit is already in their portfolios.




EXAMPLE:

Compute for the expected rate of return ofthe stock with a current price of 100 and is

estimated to have a price of 110 at the endof the period. The company issues 10pesos dividends per share.



C. The Valuation ModelThe sources of gains from a stock are cash dividendsand capital gains. Over the investors holding period,say one year, his expected rate of return will becomputed as:

Where: y= expected rate of return

Po= current price of the stock

P1= estimated price at the end of the period

D1= cash dividends expected over theperiod




Is the investors find that the stock will yield areturn higher than its cost of capital,investors will want to acquire that stock andbid up its price, decreasing expected returns

to investors. If many investors are well- informed about

the stocks prospects and share expectations,the stocks price will quickly approximate its

economic or intrinsic value, and the investorsexpected rate of return will approximate hisrequired rate of return.




Try this!

SMC Shares: Compute for the expectedrate of return of the stock with a current

price of 85 and is estimated to have a priceof 90 at the end of the period. Thecompany issues 0.35 pesos dividends pershare.



Price Adjustment

Adjustments to market price as a result ofchanges in certain types of corporateactions.

Estimation of a benchmark adjustedmarket price is that if the corporate actionis purely nominal.

There are no real cash flows involved.Without any cash flow implication, theeconomic value of the company will notchange.



Price AdjustmentThe corporate action itself does not directly link to

a cash flow change; the action may haveinformation value. It is used by the corporationto signal to investors something more substantial

about corporate plans and strategies. Relevant information is quite difficult to find to

predict patterns of undervaluation in the market.Analyst oftentimes poring over to common

information. In many cases, the seeming undervaluation turns

out to be the consequence of some benefit, cost,or risk heretofore unrecognized.



Patterns of undervaluation and

Above-Market Performance

Underpricing of Initial Public Offerings

A possible explanation is that the underpricing iscompensation for some hidden cost or risk borneby the underwriter. Since some portion of the IPOmust eventually be passed on to the public whocannot be asked to pay the hidden cost, the luckyinvestor here is a free rider.



Patterns of undervaluation and

Above-Market Performance

The payment of stock dividends is anothercorporation which could produce above-

average performance.

The Calendar Effect refers to a pattern of

seasonal above-average performance (orunderperformance0 in certain months of theyear, days of the week, holidays and the like.



Summary

The valuation of a stock and the assessment ofits corresponding Price-earnings Ratio (PER) are

critical concerns to an investors, and areessential steps in fundamental analysis. Theobject of this process is to determine whether astock is undervalued, overvalued, of fully valued

at its current market price.



Summary

Also, benchmark price adjustments to certaincorporate actions (e.g. stock dividends and stockrights) are also discussed.

We also discussed certain types of marketbehavior which can be potential sources ofabove-normal returns for the investor. Such

patterns are noteworthy that they may berecurring and have been observed in both localand foreign stock markets.

Common Stock...

Documents

Transcript of Common Stock...