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1、,CHAPTER 5Stocks and Their Valuation,Features of common stockDetermining common stock valuesEfficient marketsPreferred stock,Represents ownership.Ownership implies control.Stockholders elect directors.Directors hire management.Since managers are “agents” of shareholders, their goal should be: Maximi
2、ze stock price.,Common Stock: Owners, Directors, and Managers,Classified stock has special provisions.Could classify existing stock as founders shares, with voting rights but dividend restrictions.New shares might be called “Class A” shares, with voting restrictions but full dividend rights.,Whats c
3、lassified stock? How might classified stock be used?,The dividends of tracking stock are tied to a particular division, rather than the company as a whole.Investors can separately value the divisions.Its easier to compensate division managers with the tracking stock. But tracking stock usually has n
4、o voting rights, and the financial disclosure for the division is not as regulated as for the company.,What is tracking stock?,When is a stock sale an initial public offering (IPO)?,A firm “goes public” through an IPO when the stock is first offered to the public.Prior to an IPO, shares are typicall
5、y owned by the firms managers, key employees, and, in many situations, venture capital providers.,What is a seasoned equity offering (SEO)?,A seasoned equity offering occurs when a company with public stock issues additional shares.After an IPO or SEO, the stock trades in the secondary market, such
6、as the NYSE or Nasdaq.,Dividend growth modelUsing the multiples of comparable firmsFree cash flow method (covered in Chapter 12),Different Approaches for Valuing Common Stock,One whose dividends are expected togrow forever at a constant rate, g.,Stock Value = PV of Dividends,What is a constant growt
7、h stock?,For a constant growth stock,If g is constant, then:,$,0.25,Years (t),0,What happens if g rs?,If rs 0:,= = = $9.89.,$2.00(0.94),0.13 - (-0.06),$1.88,0.19,What are the annual dividendand capital gains yield?,Capital gains yield = g = -6.0%.Dividend yield= 13.0% - (-6.0%)= 19.0%.Both yields ar
8、e constant over time, with the high dividend yield (19%) offsetting the negative capital gains yield.,Analysts often use the P/E multiple (the price per share divided by the earnings per share) or the P/CF multiple (price per share divided by cash flow per share, which is the earnings per share plus
9、 the dividends per share) to value stocks. Example:Estimate the average P/E ratio of comparable firms. This is the P/E multiple.Multiply this average P/E ratio by the expected earnings of the company to estimate its stock price.,Using the Stock Price Multiples to Estimate Stock Price,The entity valu
10、e (V) is:the market value of equity (# shares of stock multiplied by the price per share)plus the value of debt.Pick a measure, such as EBITDA, Sales, Customers, Eyeballs, etc.Calculate the average entity ratio for a sample of comparable firms. For example,V/EBITDAV/Customers,Using Entity Multiples,
11、Find the entity value of the firm in question. For example,Multiply the firms sales by the V/Sales multiple.Multiply the firms # of customers by the V/Customers ratioThe result is the total value of the firm.Subtract the firms debt to get the total value of equity.Divide by the number of shares to g
12、et the price per share.,Using Entity Multiples (Continued),It is often hard to find comparable firms.The average ratio for the sample of comparable firms often has a wide range.For example, the average P/E ratio might be 20, but the range could be from 10 to 50. How do you know whether your firm sho
13、uld be compared to the low, average, or high performers?,Problems with Market Multiple Methods,Why are stock prices volatile?,rs = rRF + (RPM)bi could change. Inflation expectations Risk aversion Company risk g could change.,Stock value vs. changes in rs and g,D1 = $2, rs = 10%, and g = 5%:P0 = D1 /
14、 (rs-g) = $2 / (0.10 - 0.05) = $40.What if rs or g change?ggg rs4%5%6%9%40.0050.0066.6710%33.3340.0050.0011%28.5733.3340.00,Are volatile stock prices consistent with rational pricing?,Small changes in expected g and rs cause large changes in stock prices.As new information arrives, investors continu
15、ally update their estimates of g and rs.If stock prices arent volatile, then this means there isnt a good flow of information.,What is market equilibrium?,In equilibrium, stock prices are stable.There is no general tendency for people to buy versus to sell.The expected price, P, must equal the actua
16、l price, P. In other words, the fundamental value must be the same as the price.,(More),In equilibrium, expected returns mustequal required returns:,rs = D1/P0 + g = rs = rRF + (rM - rRF)b.,How is equilibrium established?,If rs = + g rs, then P0 is “too low.”If the price is lower than the fundamenta
17、l value, then the stock is a “bargain.”Buy orders will exceed sell orders, the price will be bid up, and D1/P0 falls until D1/P0 + g = rs = rs.,D1P0,Why do stock prices change?,ri = rRF + (rM - rRF )bi could change. Inflation expectations Risk aversion Company risk g could change.,Whats the Efficien
18、t MarketHypothesis (EMH)?,Securities are normally in equilibrium and are “fairly priced.” One cannot “beat the market” except through good luck or inside information.,(More),1.Weak-form EMH:Cant profit by looking at past trends. A recent decline is no reason to think stocks will go up (or down) in t
19、he future. Evidence supports weak-form EMH, but “technical analysis” is still used.,2.Semistrong-form EMH:All publicly available information is reflected in stock prices, so it doesnt pay to pore over annual reports looking for undervalued stocks. Largely true.,3.Strong-form EMH:All information, eve
20、n inside information, is embedded in stock prices. Not true-insiders can gain by trading on the basis of insider information, but thats illegal.,Markets are generally efficient because:,1.100,000 or so trained analysts-MBAs, CFAs, and PhDs-work for firms like Fidelity, Merrill, Morgan, and Prudentia
21、l.2.These analysts have similar access to data and megabucks to invest.3.Thus, news is reflected in P0 almost instantaneously.,Preferred Stock,Hybrid security.Similar to bonds in that preferred stockholders receive a fixed dividend which must be paid before dividends can be paid on common stock.However, unlike bonds, preferred stock dividends can be omitted without fear of pushing the firm into bankruptcy.,Whats the expected return on preferred stock with Vps = $50 and annual dividend = $5?,
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