Stock Valuation 1

7/28/2019 Stock Valuation 1

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Unit 2

Stock Valuation


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What is the need for Stock Valuation?

Rs 25000

Market price

Rs 110 per share

IS it worth to buy this share @ Rs 110 ?

Mr Sharma


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How Mr Sharma will see the value of his investment

in ITC Ltd?

Expected Return

Dividend Discount

Model

Free Cash FlowMethod

Relative Valuation


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Determining the value of stock based on

Expected Return

Let us understand how to calculate expected return.

One share for Rs 110 Dividend = Rs 5

Expected

sale price = Rs 120

Hold for 1 year

Expected return = (Income/Investment) * 100

= ( 5 + (120 -110)/110)*100

= 13.63 %


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Calculation of Expected Return

One share for Rs 110 Dividend = Rs 5

Expected

sale price = Rs 120

Expected return = Income x 100

Purchase price

= (Dividend +Capital gain)/Purchase price x 100

= 5 + (120 -110 ) x 100

110

= 13.63 %

Expected return = D1 + (P1

P0)P0


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Determining the value of stock based on Expected

Return

? Rs 110

10 %

1 Year

P FV = P(1+K)n Rs 110

Rs 110P = FV/(1+K)n

Rs 100


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Determining the value of stock based on Expected

Return

Dividend = Rs 10

Expected sale price = Rs

135

1 year K = 15 %

Price = ? P = FV/(1+K)n

P = (10 + 135)/(1.15)1

= Rs 126

The maximum price that can be paid is equal to the present value of future cash flows


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Dividend Discount Models


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Case 1 : One year investment in stock

Dividend Discount Models


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Dividend discount model

What is the need for dividend discount model?

Investors are always interested in knowingthe intrinsic value or the fair value of a share

The dividend discount model helps to

identify overvalued and under valued stocks


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Dividend discount model discounts the dividend receivable infuture to arrive at the present value of the stream of dividends

The value so arrived is the fair value or intrinsic value of the

stock

What is Dividend discount model?

D = Rs 10

P1 = Rs 140

K = 20 %

P = FV/(1+K)n

P = 150/(1.20)1

1 year

P = 125


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Case 2: Investing in stock for more than 1 year

DDM

Po D1 D2 D3 D4 Dn + Pn

K


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Constant Growth Dividend DiscountModel


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Growth in dividend = 10 %

Do = 5 5.5 6.05 6.65 7.32

D1 =5(1.10)1

5(1.10)2

5(1.10)3

5(1.10)4

5(1.10)n

0 1 2 3 4 n


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Constant growth dividend discount

model


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Higgins Sustainable Growth Rate


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Let us suppose Mr. Prince had invested Rs 50,000 in a small coffee

Shop. Last year he earned a net income of Rs 5000.

Assume that he is the only shareholder in his business and the whole

Investment is made out of his pocket.

He always maintain 10 % return on his investments

Out of Rs 5000 net income he took back Rs 2000 as dividend income

and re-invested Rs 3000 into the business.

Note: Prince bought one micro wave oven for Rs 3000

What will be the NI for the current year?


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Invested Capital

Rs 50,000

Income

Rs 5000

ROE OF 10 %

Rs 2000 Rs 3000

Pay out ratio 40 % Re-investment

ratio 60 %

Income

Rs 5300

ROE OF 10 %

Invested Capital

Rs 53,000

Rs 2120 Rs 3180

Pay out ratio 40 % Re-investment

ratio 60 %

Invested Capital

Rs 56,180

Income

Rs 5618

ROEOF 10 %

6 %6 %

0 1 2


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Free cash flow method (FCFF)


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Relative Valuation Method

It is the process of finding the value of an

asset based on how similar assets are priced in

the market.

Price earning ratio

Price to book value.


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Thank You

For any clarifications, please write to me at

[email protected]

Documents

Stock Valuation 1