11/16/2018 Nattawoot Koowattanatianchai 1 Investment Analysis - PowerPoint PPT Presentation

11/16/2018 Nattawoot Koowattanatianchai 1

Investment Analysis & Portfolio Management Assistant Professor Nattawoot Koowattanatianchai, DBA, CFA 11/16/2018 Nattawoot Koowattanatianchai 2

 Em Email: :  fbusn snwk@k wk@ku. u.ac. c.th th  Homepag age: e:  http:// tp://fin. in.bu bus. s.ku. ku.ac. c.th/nattaw h/nattawoot.h oot.htm tm  Ph Phone:  02 02-942 4287 8777 77 Ext. t. 1212  Mobile le: :  087 087- 5393525 5393525  Of Offic fice: e: th floor,  9 th r, KBS Building 4 11/16/2018 Nattawoot Koowattanatianchai 3

Lecture 2 Stock Valuation: Dividend Discount Model 11/16/2018 Nattawoot Koowattanatianchai 4

Discussion topics  The present value of common stocks  Estimates of parameters in the Dividend Discount Model  The stock markets 16/11/61 Nattawoot Koowattanatianchai 5

Readings  Ross, S., Westerfield, R. and Jaffe, J. (2010), Corporate Finance (9 th Edition), McGraw Hill/Irvin. (Chapters 9 and 15)  CFA Program Curriculum 2015 - Level II – Volume 4: Equity. 16/11/61 Nattawoot Koowattanatianchai 6

Features of common stocks  Voting right  Shareholders elect directors who, in turn, hire management to carry out their directives.  Cumulative voting  The directors are elected all at once.  This permits minority participation.  Total number of votes = number of shares × number of directors to be elected 11/16/2018 Nattawoot Koowattanatianchai 7

Features of common stocks  Voting right  Cumulative voting  If there are Ɲ directors up for election, then [1/(Ɲ +1)] percent of the stock plus one share will guarantee you a seat.  Example: Stock in JRJ Corporation sells for $20 per share and features cumulative voting. There are 10,000 shares outstanding. If three directors are up for election, how much does it cost to ensure yourself a seat on the board.  2,501 × $20 = $50,020 11/16/2018 Nattawoot Koowattanatianchai 8

Features of common stocks  Voting right  Straight voting  The directors are elected one at a time.  This guarantees that a majority will win every seat.  Staggered election  Only a fraction of the directorships are up for election at a particular time.  Staggering makes it more difficult for a minority to elect a director when there is cumulative voting.  Staggering makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors. 11/16/2018 Nattawoot Koowattanatianchai 9

Features of common stocks  Proxy voting  A proxy is the grant of authority by a shareholder to someone else to vote her shares.  Used in large companies with large number of shareholders.  Management always tries to get as many proxies as possible transferred to it. However, if shareholders are not satisfied with management, an “outside” group of shareholders can try to obtain votes via proxy. They can vote by proxy in an attempt to replace management by electing enough directors. The resulting battle is called a proxy fight. 11/16/2018 Nattawoot Koowattanatianchai 10

Features of common stocks  Classes of stock  Often, the classes are created with unequal voting rights.  A primary reason for creating dual or multiple classes of stock has to do with control of the firm. If such stock exists, management of a firm can raise equity capital by issuing nonvoting or limited-voting stock while maintaining control. 11/16/2018 Nattawoot Koowattanatianchai 11

Features of common stocks  Other rights  The right to share proportionally in dividends paid.  The right to share proportionally in assets remaining after liabilities have been paid in a liquidation.  The right to vote on stockholder matters of great importance, such as merger.  The right to share proportionally in any new stock sold ( preemptive right ). 11/16/2018 Nattawoot Koowattanatianchai 12

Features of common stocks  Dividends  Unless a dividend is declared by the board of directors of a corporation, it is not a liability of the corporation.  Corporations cannot default on an undeclared dividend. As a consequence, corporations cannot become bankrupt because of nonpayment of dividends.  The payment of dividends by the corporation is not a business expense, and is, therefore, not deductible for tax purposes. 11/16/2018 Nattawoot Koowattanatianchai 13

Features of common stocks  Dividends  Dividends received by individual shareholders are taxable. However, corporations that own stock in other corporations are excluded from paying taxes if  the corporation holds at least 25% of outstanding stocks;  the stock has been held for at least 3 months before and after the dividend payment; and  the corporation paying dividends does not hold any stocks of the corporation receiving those dividends. 11/16/2018 Nattawoot Koowattanatianchai 14

Stock valuation  Selecting the appropriate valuation model  Absolute valuation model  specifies an asset’s intrinsic value using present value models.  Dividen idend d Disc scou ount nt Mode del  Free Cash Flow Model  Residual Income model  Relative valuation model  estimates an asset’s value relative to that of another asset.  Price multiples  Enterprise value multiples 11/16/2018 Nattawoot Koowattanatianchai 15

The PV of common stocks  The value of any asset is the present value of its expected future cash flows.  Stock ownership produces cash flows from:  Dividends  Capital Gains  Valuation with a short-term holding period  Valuation with indefinite holding period  Zero Growth  Constant Growth  Differential Growth 11/16/2018 Nattawoot Koowattanatianchai 16

Dividend Discount Model  Assume that R = appropriate discount rate, P = selling price, Div = dividend  P 0 = Div 1 /(1+R) + P 1 /(1+R)  P 1 = Div 2 /(1+R) + P 2 /(1+R)  etc. Div Div Div     1 2 3  P    0 1 2 3 ( 1 R ) ( 1 R ) ( 1 R ) 11/16/2018 Nattawoot Koowattanatianchai 17

Case 1: a single holding period  Suppose that you expect Carrefour SA (NYSE Euronext Paris: CA) to pay a € 0.58 dividend next year. You expect the price of CA stock to be € 27.00 in one year. The required rate of return for CA stock is 9%. What is your estimate of the value of CA stock?  P 0 = Div 1 /(1+R) + P 1 /(1+R) = 0.58/1.09 + 27 /1.09 = 25.30 11/16/2018 Nattawoot Koowattanatianchai 18

Case 2: multiple holding periods  For the next five years, the annual dividends of a stock are expected to be $2.00, $2.10, $2.20, $3.50, and $3.75. In addition, the stock price is expected to be $40.00 in five years. If the required return on equity is 10%, what is the value of this stock? 2 2.10 2.20 3.50 3.75 40       P 0 1 2 3 4 5 5 ( 1 . 1 ) ( 1 . 1 ) ( 1 . 1 ) ( 1 . 1 ) ( 1 . 1 ) ( 1 . 1 )  P 3 4 . 76 0 11/16/2018 Nattawoot Koowattanatianchai 19

Case 3: zero growth  Assume that dividends will remain at the same level forever.     Div Div Div 1 2 3  Since future cash flows are constant, the value of a zero growth stock is the present value of a perpetuity: Div Div Div      P    0 1 2 3 ( 1 R ) ( 1 R ) ( 1 R ) Div  P 0 R 11/16/2018 Nattawoot Koowattanatianchai 20

Case 3: zero growth  Assume that a stock will pay $1 of annual dividends forever. If the required return on equity is 15% , determine whether investors should purchase this stock at the current market price of $5?  Investors should buy this stock because it is currently undervalued (market value < intrinsic value). Div 1    P 0 6 . 67 R . 15 11/16/2018 Nattawoot Koowattanatianchai 21

Case 4: constant growth  Assume that dividends will grow at a constant rate, g, forever, i.e.,   Div Div ( 1 g) 1 0     2 Div Div ( 1 g) Div ( 1 g) 2 1 0     3 Div Div ( 1 g) Div ( 1 g) 3 2 0 . . . 11/16/2018 Nattawoot Koowattanatianchai 22

Case 4: constant growth  Since future cash flows grow at a constant rate forever, the value of a constant growth stock is the present value of a growing perpetuity: Div   1 P ; R g  0 R g 11/16/2018 Nattawoot Koowattanatianchai 23

Case 4: constant growth  Suppose Big D, Inc., just paid a dividend of $1. It is expected to increase its dividend by 8% per year. If the market requires a return of 15% on assets of this risk level, how much should the stock be selling for?  Div 1(1 .08)    1 P 15 . 43   0 R g . 15 . 08 11/16/2018 Nattawoot Koowattanatianchai 24

Case 5: differential growth  Assume that dividends will grow at different rates in the foreseeable future and then will grow at a constant rate thereafter.  To value a Differential Growth Stock, we need to:  Estimate future dividends in the foreseeable future.  Estimate the future stock price when the stock becomes a Constant Growth Stock (case 4).  Compute the total present value of the estimated future dividends and future stock price at the appropriate discount rate. 11/16/2018 Nattawoot Koowattanatianchai 25