Stock valuation is the process of determining the intrinsic or fair value of a company's stock. Investors and analysts use various methods to assess the worth of a stock to make informed decisions about buying, selling, or holding the shares. Here are some common approaches to stock valuation:
1. Fundamental Analysis:
This method involves analyzing a company's financial statements, industry position, management team, and economic outlook to estimate its true value. Key financial ratios and metrics, such as price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, and dividend yield, are often used in this approach.
2. Price-to-Earnings Ratio (P/E Ratio):
The P/E ratio is one of the most popular valuation metrics. It compares the stock price to the company's earnings per share (EPS). A high P/E ratio may indicate that the stock is overvalued, while a low P/E ratio may suggest an undervalued stock. However, it's crucial to consider the company's growth prospects and industry norms when interpreting the ratio.
3. Price-to-Book Ratio (P/B Ratio):
The P/B ratio compares the stock's market value to its book value (total assets minus intangible assets and liabilities). A P/B ratio below 1 may indicate that the stock is undervalued, but it's essential to assess the company's financial health and future growth prospects.
4. Discounted Cash Flow (DCF) Analysis:
DCF analysis estimates the present value of a company's future cash flows, considering factors like projected revenue, expenses, and capital expenditures. This method attempts to determine the intrinsic value of a stock based on its ability to generate cash flow in the future.
5. Dividend Discount Model (DDM):
DDM is used to value stocks that pay dividends regularly. It calculates the present value of expected future dividends, considering factors like dividend growth rate and discount rate.
6. Comparable Company Analysis (CCA):
In CCA, analysts compare the valuation multiples (P/E, P/B, etc.) of the company in question with those of similar publicly-traded companies. This approach assumes that similar companies in the same industry should have similar valuation ratios.
7. Comparable Transaction Analysis (CTA):
Similar to CCA, CTA compares the valuation of the target company with prices paid for similar companies in recent mergers and acquisitions. It's essential to note that stock valuation is not an exact science, and different methods can yield varying results. Additionally, stock prices are influenced by market sentiment, geopolitical events, and overall market conditions, which might not always reflect a company's true intrinsic value. Therefore, it's crucial for investors to consider multiple factors and use a combination of valuation methods to make well-informed investment decisions.
Abbreviation
Po = Current price/Present price/intrinsic value of share
P1=coming year price /next year price/ expected price of share
D0=Current dividend/present dividend/last year dividend
D1= coming year dividend/next year dividend/ expected dividend/Year end dividend
Eo=Current earnings per share /present earning per share
E1=next year Earnings per share / Expected earnings per share
Ke=Cost of equity/cost of capital/expected rate of return/discount rate/opportunity cost/required rate of return
G=Growth rate/Increasing rate of dividend
B=Retention ratio/ percentage of retain earnings
r=return on equity/rate of return
D/p ratio=Dividend payout ratio
Common stock valuation methods
There are three methods to valuation of common stock
1.Zero Growth Model
2.Constant growth Model
3.Dividend discount Model(DDM)
Let’s to discuss some Important formula
Under Zero growth Model
1.Po=Do/Ke [ where no mention growth rate in the sum)
Under constant growth Model
2.Po=D1/Ke-g[ where mention growth rate in the sum)
Under dividend discount Model(DDM)
There are two parts in dividend discount Model (DDM)
1.Single period Valuation Model
3.Po=d1+p1/1+ke
2.Multi period valuation model
4.po=D1 /(1+ke)1 D2 /(1+ke)2+ …….Dn+pn/(1+ke)n
5.=g=b*r
6. b=1-D/p ratio
7.D/P ratio=1-b
8.Po=Eo*D/P ratio
9.P1=E1* D/p ratio
10.D1=D0(1+g)
Practical Example -01
ABC company pays a dividend of Tk.10 per share. Company’s growth rate is zero percent. If the cost of equity is 12%. What will be the present value of share?
We know that,
Po = Do/Ke
= 10/0.12
= Tk.83.33
Practical Example -02
A company currently pays a dividend of Tk.3.50 per share which is expected to remain unchanged. Investor requires 13% return on this stock. What is the price of the share?
We know that,
Po = Do/Ke
= 3.50/0.13
= Tk.26.92
Practical Example -03
wimax company sell share for Tk.25 and required rate of return is 12% then calculate current payment dividend.
We know that,
Po = Do/Ke
or, 25= Do/0.12
or, Do=25*.12
or = Tk.3.00
Practical Example -04
ABC company currently pays a dividend of Tk.3 per share which is not expected to changed in future . The current price of the stock Tk.12.What is the expected rate of return on this stock?
We know that,
Po = Do/Ke
or, 12 = 3/Ke
or, Ke =3/12
or = 0.25 or,25%
Practical Example -05
ABC company currently pays a dividend of Tk.20 per share which is expected to grow at 5% indefinitely. cost of common stock is 15%. calculate the value of common stock.
Here, D1=Do(1+g)=20(1+0.05)=21
We know that,
Po = D1/Ke-g
= 21/0.15-0.05
= 21/0.10
= Tk.210
Practical Example -06
XYZ incorporation currently pays a dividend of Tk.2.50 per share at the end of the year .It plants to increase this dividend by 5% next year and maintain it at the new level for the foreseeable future. if the required return on this firms stock is 8% .what is the value of common stock ?
Here, D1=Do(1+g)=2.50(1+0.05)=2.625
We know that,
Po = D1/(Ke-g)
= 2.625/(0.08-0.05)
= 2.625/0.03
= Tk.87.50
Practical Example -07
Fresh product currently selling for Tk.45 per share with expected dividend in the coming year of Tk.2 per share. If the growth rate in dividends expected by investors is 8%, what is the required rate of return for this stock?
We know that,
Po = D1/Ke-g
or 45 = 2/Ke-0.08
or 45 (Ke-0.08)= 2
or Ke-0.08= 2/45
or Ke =0.0444+0.08
or Ke=0.1244
or,12.44%
Practical Example -08
ZYZ company,s equity share currently sells for Tk. 23 per share. the company's finance manager anticipates a constant growth rate of 10.50% and an end of the year dividend of Tk.2.50.If the investor requires a 17% return, should he purchase the stock?
We know that, Here, D1=2.50
Po = D1/Ke-g
= 2.50/0.17-0.105
Tk. 38.46
Comment: The investor should purchase the stock because estimated price (38.046>23) is higher than current selling price.
Practical Example -09
ABC company currently has an EPS of Tk.40 and dividend payout ratio is 40%. An investor required a 14% on this kind of investment.Growth rate is 8%. what is the value of ABC,s share?
Here , EPS=40,
D0=40*40%=16
g=8% or,0.08
D1=D0(1+g)=16+1.08=17.28
Ke= 14% or 0.14
We know that,
Po = D1/Ke-g
= 17.28/0.14-0.08
= 17.28/0.06
Tk. 288
Practical Example -10
ABC Motor is currently selling for Tk.100 per share and pays Tk.5 as dividend. Investors requires 12% rate of return on this stock. What is the expected growth rate of dividend?
We know that,
Po = D1/Ke-g
or 100 = 5/0.12-g
or,0.12-g = 5/100
or-g=0.05-0.12
or-g= -0.07
or g =0.07
or 7%
Under dividend discount Model(DDM)
There are two parts in dividend discount Model (DDM)
1.Single period Valuation Model
3.Po=D1+p1/1+ke [Po, P1, D1, Ke use this formula when missing any of this elements]
Practical Example -11
An investor purchase the common stock of a well known house builder farms construction company for Tk. 25 per share . The Expected dividend for the next year is Tk.3 per share and the investor is confident that the stock can be sold one year from now for Tk. 30. what is the implied required rate of return?
We know that,
Po = D1+P1 / 1+Ke
or, 25 = 3+30 / 1+Ke
or,25 = 33 / 1+Ke
or,25(1+Ke) = 33
or,1+Ke = 33/25
or,1+Ke = 33/25
or,1+Ke = 1.32
or, Ke = 1.32-1
or, Ke =0.32
or, 32%
Practical Example -12
Kalpana is expected to pay Tk.3.50 as dividend in the next year and the market price is projected to be Tk.85 by the year end. if the investor required rate of return is 13%. what is the current value of the stock?
We know that,
Po = D1+P1 / 1+Ke
= 3.50+85 / 1+0.13
= 88.50 / 1.13
Tk.78.32
Practical Example -13
Market price par share=Tk.3000 ,Dividend paid per share =TK.100, required rate of return=25%
Requirement
1.Intrinsic value of share
2.Would you buy the share for Tk.2200
Ans:
Req-01
We know that,
Po = D1+P1 / 1+Ke
= 100+3000 / 1+0.25
= 3100 / 1.25
Tk.2480
Req-02 comments
Capital gain=2480-2200=Tk.280
So,it is wise to buy the share
Under dividend discount Model(DDM)
02.Multi period valuation model
4.po=D1 /(1+ke)1 D2 /(1+ke)2+ …….Dn+pn/(1+ke)n
5.=g=b*r
6. b=1-D/p ratio
7.D/P ratio=1-b
8.Po=Eo*D/P ratio
9.P1=E1* D/p ratio
10.D1=D0(1+g)
Practical Example -14
EMC corporation just paid a dividend of Tk.1.50. The dividend is expected to grow at 5% a year for the next 03 years and then 10% a year there after. if the firms required rate of return is 13% then find the market value of EMC corporation?
Here ,Do=1.50
r=13% or,0.13
n=3, g=5%(3 years),g=10%(after 3 years)
W-1.Calculation of expected dividend:
D1=Do(1+g)=1.50(1+0.05)=1.58
D2=D1(1+g)=1.58(1+0.05)=1.66
D3=D2(1+g)=1.66(1+0.05)=1.74
D4=D3(1+g)=1.74(1+0.05)=1.91
W-2.Calculation of present value of dividend(pvd):
Pv=D1/(1+r)n + D2/(1+r)n + D3/(1+r)n+D1/(1+r)n
=1.58/(1+0.13)1 + 1.66/(1+0.13)2 + D3/(1+0.13)3
=1.40+1.30+1.21
=Tk.3.91
W-3. P3 = D4 /(ke-g)
= 1.91 /(0.13-0.10)
Tk.63.67
W-4. Pv of P3=p3/(1+r)n
=63.67 /(1+0.13)3
=Tk.44.13
Po=Pv of dividend +Pv of P3
=3.91+44.13
=Tk.48.04
Practical Example -15
Bangladesh lamps Ltd. currently pays an annual dividend of Tk.18. per share of common stock. The required rate of return of the common stock of the company is 12%. Estimate value of the common stock under assumption that dividend are expected to grow at an annual rate of 5% for each of the next 3 years followed by a constant growth rate of 4% from year four to infinity.
Solved
Here is given,Do=18 r=12%,N=3,G=5%(3years),G=4(after 3 years)
W-1.Calculation of expected dividend:
D1=Do(1+g)=18(1+0.05)=18.90
D2=D1(1+g)=18.90(1+0.05)=19.85
D3=D2(1+g)=19.85(1+0.05)=20.84
D4=D3(1+g)=20.84 (1+0.05)=21.67(forP3)
W-2.Calculation of present value of dividend(pvd):
Pv=D1/(1+r)n + D2/(1+r)n + D3/(1+r)n
=18.90/(1+0.12)1 + 19.85/(1+0.12)2 + 20.84/(1+0.12)3
=16.875+15.824+14.834
=Tk.47.53
W-3. P3 = D4 /(ke-g)
= 21.67 /(0.12-0.04)
Tk.271
W-4. Pv of P3=p3/(1+r)n
=271/(1+0.12)3
=Tk.192.90
Po=Pv of dividend +Pv of P3
=47.53+192.90
=Tk.240.43(Ans)