Professional Documents
Culture Documents
CHAPTER 9
Stocks and Their Valuation
Represents ownership.
Ownership implies control.
Stockholders elect directors.
Directors elect management.
Managements goal: Maximize
stock price.
D1 D2 D3 D
P . . .
0
1 k 1 k 1 k
s
1
s
2
s
3
1 k
s
D1 D0 1 g
1
D2 D0 1 g
2
Dt Dt 1 g
t
If g is constant, then:
P D0 1 g
D1
ks g ks g
0
Dt
0.25
PVD t
1 k t
If g > k, P0 !
P0 PVD t
0 Years (t)
Copyright 1999 by The Dryden Press All rights reserved.
9-8
D1
P 0 requires k s > g.
ks g
If ks< g, get negative stock price,
which is nonsense.
We cant use model unless (1) g < ks
and (2) g is expected to be constant
forever. Because g must be a long-
term growth rate, it cannot be > ks.
Copyright 1999 by The Dryden Press All rights reserved.
9-9
0 g=6% 1 2 3 4
P
D0 1 g
D1
ks g ks g
0
$2.12 $2.12
= = $30.29.
0.13 - 0.06 0.07
Copyright 1999 by The Dryden Press All rights reserved.
9 - 12
D1 $2.12
Dividend yield = = = 7.0%.
P0 $30.29
^
P1 - P0 $32.10 - $30.29
CG Yield = =
P0 $30.29
= 6.0%.
Copyright 1999 by The Dryden Press All rights reserved.
9 - 14
D1 D1
P0 to k s g.
ks g P0
^
Then, ks = $2.12/$30.29 + 0.06
= 0.07 + 0.06 = 13%.
What would P0 be if g = 0?
^ PMT $2.00
P0 = = = $15.38.
k 0.13
Copyright 1999 by The Dryden Press All rights reserved.
9 - 17
At t = 0:
D1 $2.60
Dividend yield = = = 4.8%.
P0 $54.11
(More)
Copyright 1999 by The Dryden Press All rights reserved.
9 - 20
0 1 2 3 4
ks=13%
...
g = 0% g = 0% g = 0% g = 6%
2.00 2.00 2.00 2.12
1.7699
1.5663
1.3861
20.9895 P 2.12 30.2857
3
25.7118 0.07
Copyright 1999 by The Dryden Press All rights reserved.
9 - 24
D1 2.00
t = 0: P $25.72 7.8%.
0
Expansion Plan
^
ks = D1/P0 + g = ks = kRF + (kM -
kRF)b.
^ ^
If ks = D1 + g > ks, then P0 is too low.
P0
If the price is lower than the fundamental
value, then the stock is a bargain.
^ D1
P0
ki g
g could change.
Copyright 1999 by The Dryden Press All rights reserved.
9 - 35
(More)
Copyright 1999 by The Dryden Press All rights reserved.
9 - 36
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 the 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, even inside
information, is embedded in
stock prices. Not true--insiders
can gain by trading on the basis
of insider information, but thats
illegal.
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.
Copyright 1999 by The Dryden Press All rights reserved.
9 - 41
$5
Vps $50
k ps
$5
k ps 0 .10 10 .0%.
$50