Module 8: Stock Valuation

Key Topics

• Common Stock Valuation
• Price Computation Using Dividends
• Price Computation Using Multiples
• Discussion on the Stock Market

Sections

1. Common Stock
2. Preferred Stock
3. The Stock Market

Common Stock Valuation

Principle

• Stock Price: Present value of expected cash flows.
• Cash Flows: Include dividends and capital gains (selling stock for more than purchase price).

Example Calculation

• Example Company: Moore Incorporated
• Expected Dividend: $2 in one year
• Expected Selling Price: $14
• Required Return: 20%

Timeline & Calculation

• Future Cash Flows: $2 dividend + $14 selling price = $16 total.
• Present Value Calculation: Required return of 20%, cash flows received in one period.
• Fair Value: $13.33

Extended Period Calculation

• Two Periods Example:

  • Year 1: $2 dividend
  • Year 2: $2.10 dividend, $14.70 selling price
  • Present Value: $13.33

• Three Periods Example:

  • Continuous dividend growth model (constant price, $13.33)

Generalization

• Stock Price Consistency: Price remains constant regardless of holding period.
• Gordon Model: Simplifies calculations for infinite periods.

The Gordon Model

Formula

• Price of Stock (P₀): ( P_0 = \frac{D_0(1+G)}{R-G} )
  • ( D_0 ): Initial dividend
  • ( G ): Growth rate of dividends
  • ( R ): Required rate of return

Application

• Growth Scenarios:
  • Positive growth
  • Negative growth
  • Zero growth (( G = 0 ): Formula simplifies to ( D/R ))

Example Calculation

• Company: Big D Incorporated
• Last Dividend: $0.50/share
• Growth Rate: 2%
• Required Return: 15%
• Stock Price: $3.92

Alternative Valuation Using Multiples

• P/E Ratio Approach
  • Formula: Price = P/E Ratio x EPS
  • P/E Ratio: Often industry average

Example

• Company EPS: $3
• Industry P/E: 12
• Estimated Price: $36

End of Lecture Transcript Section