1 c hapter 6 common stock valuation chapter sections: security analysis: be careful out there the...

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CHAPTER 6Common Stock Valuation

Chapter Sections:Security Analysis: Be Careful Out ThereThe Dividend Discount ModelThe Two-Stage Dividend Growth ModelThe Residual Income ModelThe Free Cash Flow ModelPrice Ratio AnalysisAn Analysis of the McGraw-Hill Company

“Value matters. You ignore value at your peril.” Greg Ireland, mutual fund manager with over 35 years experience

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Common Stock Valuation Stock Valuation

The process by which the underlying value of a stock is established on the basis of its forecasted risk and return performance

At any given time, the price of a share of common stock depends on investors’ expectations about the future behavior of the security

A fundamental assertion of finance holds that the value of a stock is based on the present value of its future cash flows (a.k.a. earnings)

The worth of a company is primarily based on the earnings the company will produce in the future. But if we knew what was going

to happen in the future, it would not be called the future, would it?

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Common Stock Valuation Stock Valuation

“The most fundamental influence on stock prices is the level and duration of the future growth of earnings and dividends. [However,] future earnings growth is not easily estimated, even by market professionals.” – Burton Malkiel, A Random Walk Down Wall Street

So, if someone were to ask you, “What is the most important factor in determining the future value of a company?” In a few words, you could say, “FUTURE EARNINGS!” (or FUTURE DIVIDENDS)

But do any of us know what is going to happen in the future? “NO!”So is valuing stock going to be easy? “NO!”

(continued)

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Security Analysis Security Analysis

The process of gathering and organizing information and then using it to determine the value of a share of common stock

Intrinsic Value The underlying or inherent value of a stock, as

determined through security analysis

The question is, “What security analysis methods or measures does one use to determine the intrinsic value of a company?”

Future dividends? Potential capital appreciation? Price/earnings ratio? Financial ratios? Past price performance? Amount of risk?

Value is in the eye of the beholder.

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Fundamental Analysis Fundamental Analysis

Examination of a firm’s accounting statements and other financial and economic information to assess the economic value of a company’s stock

Examples of some of the Fundamentals: The competitive position of the company Growth prospects for company and its market Profit margins and company earnings What assets are available The company’s capital structure

How much debt, how much equity

Simply put, the value of a stock is influenced by the performance of the company that issued the stock.

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Financial Ratio Analysis Financial Ratio Analysis

One method of security analysis involves looking at certain financial ratio measures

Financial ratios give us a quick and easy method for comparing one company to other companies within their industry or the stock market as a whole

The problem with financial ratios is that there is no single financial ratio that can adequately sum up or summarize the overall general state of affairs, situation, predicament, etc., that a company finds itself in

The first financial ratios we will investigate will be price ratios.We will look at others later on.

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Price to Earnings Ratio Price to Earnings Ratio (Review)

a.k.a. Price-earnings Ratio, P/E Ratio, P/E, PE Current Price divided by Earnings per Share

Examples: FedEx (FDX), Ford (F), Facebook (FB), First Solar (FSLR)

The most popular stock market statistic! Historically, P/E ratios were in the 5 to 12 range for mature companies and 14 to 20 range for growing

companies. Greater than 20 was unusual. In the 1990’s, it was commonplace. Now, P/E ratios are all over the map!

Current Market PriceP/E Ratio = ––––––––––––––––––––––––––––––––––––

Earnings per Share (EPS)

P/E = 17.08 P/E = 2.95 P/E = 1,888 P/E = N/A

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Price to Earnings Ratio Historically,

A company’s P/E Ratio was supposed to match its growth rate. If a company was growing at 20% per year, then a P/E of 20 was justified. During the Internet bubble, many companies had P/E ratios in the hundreds eBay’s P/E was 10,000 for a time during the mania!

At that P/E, it would take eBay 10,000 years to earn its price “Growth” stocks typically have high-P/E Ratios “Value” stocks typically have low-P/E Ratios

But remember our discussion of “growth” vs “value” A “value” stock might not necessarily be a good value!

The P/E Ratio tells you how long it will take in years (assuming no changes in earnings) for the company to earn back its price. A P/E of 3 will take

three years. A P/E of 20 will take twenty years.

(continued)

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Price-to-Cash Flow Ratio Price-to-Cash Flow Ratio

Current price divided by current cash flow per share Cash flow often differs from earnings per share

For several reasons – one major reason is… Depreciation is not an actual cash expenditure

But there are many reasons cash flow & earnings differ “Good quality” versus “poor quality” earnings

During the Internet mania, many companies were reporting record earnings. At the same time, their cash flow was negative.

Huh? How could that be? Example: Lucent Technologies

Current PricePrice-Cash Flow Ratio = ––––––––––––––––––––––––––––

Cash Flow per Share

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Price-to-Sales Ratio Price-to-Sales Ratio

Current price divided by annual sales per share Historically, a higher Price-to-Sales Ratio

suggested a higher sales growth And a lower Price-to-Sales Ratio suggested a lower

sales growth

During the Internet mania, many analysts used Price-to-Sales instead of Price-to-Earnings since most all of the new companies

never generated any earnings!

Current PricePrice-to-Sales Ratio = –––––––––––––––––––––––––––––

Annual Sales per Share

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Price-to-Book Ratio Price-to-Book Ratio

Current price divided by book value Historically, if the Price-to-Book Ratio was greater

than 1.0, then shareholders believed that the firm was creating value above and beyond the physical assets of the corporation

The Book Value of a stock is the value of the assets the company possesses. Historically, it was fairly close to the price of the

stock. Today, it is rarely close to the price of the stock.

Current PricePrice-to-Book Ratio = –––––––––––––––––––––––––––––

Book Value per Share

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Applications of Price Ratio Analysis To predict future stock price using price ratios,

Multiply a historical price ratio by the expected future value price-ratio denominator (“What? Huh?”)

Price-to-Earnings Per Share Example Page 204, 6th Edition:

Intel Corp (INTC) – Price-to-Earnings (P/E) Analysis

Late-2009 stock price $19.40Late-2009 EPS $0.925-year average P/E ratio 20.96 P/EEPS growth rate 8.5%

Expected stock price = historical P/E ratio projected EPS* $20.92 = 20.96 $0.92 (1 + 0.085)

*projected EPS = current EPS * (100% + expected EPS growth rate)

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Applications of Price Ratio Analysis Applications of Price Ratio Analysis (continued)

Price-to-Cash Flow Per Share Example Page 204, 6th Edition:

Intel Corp (INTC) – Price-to-Cash Flow (P/CF) Analysis

Late-2009 stock price $19.40Late-2009 CFPS $1.745-year average P/CF ratio 10.85 P/CFCash Flow Per Share growth rate 7.5%

Expected stock price = historical P/CF ratio projected CFPS* $20.29 = 10.85 $1.74 (1 + 0.075)

*projected CFPS = current CFPS * (100% + expected CFPS growth rate)

(continued)

This is fairly close to the Price-to-Earnings estimate

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Applications of Price Ratio Analysis Applications of Price Ratio Analysis (continued)

Price-to-Sales per Share Example Page 204, 6th Edition:

Intel Corp (INTC) – Price-to-Sales (P/S) Analysis

Late-2009 stock price $19.40Late-2009 SPS $6.765-year average P/S ratio 3.14 P/SSales Per Share growth rate 7.0%

Expected stock price = historical P/S ratio projected SPS* $22.71 = 3.14 $6.76 (1 + 0.07)

*projected SPS = current SPS * (100% + expected SPS growth rate)

(continued)

A bit more optimistic, yes?

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Reality Check! Can we reasonably assume that the formulas

on the previous slides will give us realistic figures? For many companies, yes For many companies, no

But there are countless other factors at work It is like trying to predict the weather – only worse!

The major assumption of these models is that the price multiples will remain constant. However, we are using averages without taking

into account the variances and standard deviations of the averages. (Remember them?) Is it reasonable to expect predictions from these

models to be accurate if the variances of the averages are large?

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Reality Check! For the record, the price of Intel one year later

in late-2010 was around $20.50 Not bad, eh? Well, one out of four ain’t good! The predictions from the 3rd, 4th, and 5th editions for

the next year prices of Intel were far from the actual prices 3rd edition predictions: $19.61, $27.54, and $31.63

The actual price one year later was $33.50 4th edition predictions: $50.84, $43.49, and $40.92

The actual price one year later was $17.50 5th edition predictions: $25.47, $25.36, and $29.63

The actual price one year later was $20.00

Notice that the 3rd edition predictions were too low and the 4th and 5th edition predictions were too high. Gives you lots of confidence

in the price models, huh? Take heart, the predictions for Disney from the book were much closer to the actual prices.

(continued)

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Dividend Discount Models Shares of stock are valued on the basis of the

present value of the future dividend streams the stock is projected to produce

a.k.a. DDMs, Dividend Valuation Models (DVMs), Discounted Cash Flows Models

Recall: The value of a stock is based on the present value of its future cash flows Therefore, dividend discount models should be

extremely popular, right?

During the 1990’s, investors who adhered to these types of models were considered old fashioned and outdated. But those

investors weathered the 2000-2002 downturn very well. Dividends have become important again.

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Dividend Discount Model (Purest incarnation) Value of stock = present value of all expected

future dividend payments

Example 6.1: 3, 6th edition Three annual dividends of $100 per share Required rate of return = 15% ($100/1.15)+($100/1.152)+($100/1.153) = $228.32

But how many companies pay three annual dividends and then go out of business?! Plus, we keep using this term “present value.”

What does it mean anyway?

TT

3

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Dividend Discount Models(continued)

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What is “Present Value?” Present Value

The value today of a lump sum (or series of payments) to be received at some future date It is the opposite of future value! (a.k.a. the inverse)

Did you work on the optional future value calculations?

Future value of $10,000 in 10 years at 8% $10,000 * 2.1589 = $21,589 (1 + 8%) 10 years

Present value of $21,589 in 10 years at 8% $21,589 * 0.4632 = $10,000 1 1 $10,000 * 2.1589 = $21,589 (1 + 8%) 10 years

Present value and future value are just two sides of the same coin.In finance, present value tells us what the future value is worth now.

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Did the formula for the DDM scare you?

This formula has the present value calc built into it We mortals simply use the Present Value tables

Just as we used the Future Value tables in Chapter 1 The formula becomes:

PVM1 is the present value multiplier for the rate of growth for one

year, PVM2 is the multiplier for two years, etc.

(continued)

TT

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2

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k1

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Value = Dividend1*PVM1 + Dividend2*PVM2 + Dividend3*PVM3 + etc

Present Value & DDM

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Let’s do the same example over again Using the Present Value Multipliers from the

Present Value Table on the class web site http://wonderprofessor.com/123s13/Chap06/Chap06_PresentValueTable.pdf

Three annual dividends of $100 per share Required rate of return = 15%

Value = ($100*0.870) + ($100*0.756) + ($100*0.658) = $87.00 + $75.60 + $65.80 = $228.40 $228.32 (from page 183)

What is the present value of the future stream of dividends?At 15%, $100 in 1 year is worth $87, in 2 years $75.60, 3 years $65.80.

The sum of the present values of the future dividend cash flows equals our perceived value of the stock.

(continued)Present Value & DDM

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Dividend Discount Models Zero Growth Model (Not covered in our book)

Assume dividends will continue at a fixed rate indefinitely into the future

Value of stock = ───────────────

Example: Annual dividend = $3.00 per share Required rate of return = 6% $3.00 / 6% = $50.00 per share

Does the Zero Growth Model look familiar? It is simply another way to view Dividend Yield.

Annual dividends

Required rate of return

(continued)

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Dividend Discount Models Zero Growth Model (Not covered in our book)

Assume dividends will continue at a fixed rate indefinitely into the future

Value of stock = ───────────────

Dividend Yield = ───────────────

Investors who emphasize the Zero Growth Model are valuing the stock almost exclusively for its dividend yield.

Annual dividends

Required rate of return

(continued)

Annual dividendsMarket price of stock

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Dividend Discount Models Zero Growth Model (Real-life Example)

Consolidated Edison – ED (Utility income stock) Current market price is $56.58 per share (15 Feb 2013)

Currently paying $2.46 per year in annual dividends The question is, “What is our required rate of return?”

Let’s first use 8% Value = $2.46 / 8% = $30.75

The stock is overpriced if our required rate of return is 8% What about 5%? Value = $2.46 / 5% = $49.20

The stock is still too expensive if our required return is 5%

With a market price of $56.58, the stock is yielding 4.4%. The Zero Growth Model works well for stable, income-producing stocks.

(continued)

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Dividend Discount Models Constant Perpetual Growth Model

Assume dividends will continue to grow at a specified rate perpetually into the future

Value of stock = ───────────────────

Example 6.3: Page 184, 6th edition Annual dividend = $10 per share (Next year’s=$10.50) Annual dividend growth rate = 5% per year Required rate of return = 15% ($10 * 1.05) / (15% - 5%) = $10.50 / 10% = $105 The stock should be worth $105 per share

(continued)

Good for companies with consistent dividend growth.

Annual dividends * (1+Constant growth rate)

Required rate of return – Constant growth rate

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Dividend Discount Models Constant Perpetual Growth Model (Real-life Example)

Johnson & Johnson (blue chip) Current market price is $76.16 (15 Feb 2013) Currently paying $2.44 annual dividends Assume dividends growing around 8% per year

Our required rate of return is 13% ($2.44 * 1.08) / (13% - 8%) = $2.6352 / 5% $52.70

Not a great buy if we require 13%, huh? What if our required rate of return were only 10%?

($2.28 * 1.08) / (10% - 8%) = $2.6352 / 2% $131.76 What a deal!

Note: The model is very sensitive to our choice of our required rate of return

(continued)

Do you think Johnson & Johnson is a good value?

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Proctor & Gamble (blue chip) Current market price is $76.54 (15 Feb 2013) Currently paying $2.25 annual dividends Assume dividends growing around 8% per year


Proctor & Gamble doesn’t quite measure up to our 13% rate What if our required rate of return were only 10%?

($2.25 * 1.08) / (10% - 8%) = $2.430 / 2% $121.50 The model says P&G is undervalued if we require only 10%

(continued)

Are people all of a sudden going to stop using soap, toothpaste, diapers, toilet paper, shampoo, and shaving cream?

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Coca-Cola (blue chip) Current market price is $37.42 (15 Feb 2013) Currently paying $1.02 annual dividends Assume dividends growing around 8% per year


So much for caramel colored, fizzy sugar water! What if our required rate of return were only 10%?

($1.02 * 1.08) / (10% - 8%) = $1.1016 / 2% $55.08 Maybe we ought to spend more time researching KO …

(continued)

In the United States, the average person drinks over 400 Cokes a year. In China, the average is 38 per year.

In India, it is 12.Guess which country drinks the most…

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GE (blue chip) Current market price is $23.29 (15 Feb 2013) Currently paying $0.76 annual dividends Assume dividends also growing around 8% per year

What if our required rate of return is 13% ($0.76 * 1.08) / (13% - 8%) = $0.8208 / 5% $16.42

Uh, GE does not look so good if we want 13% How about 10%?

($0.76 * 1.08) / (10% - 8%) = $0.8208 / 2% $41.04 If we are happy with 10%, GE appears to be a great deal

(continued)

But this is after GE dropped its dividend down to $0.40 (from $1.24) in 2009 after decades of growing the dividend. In 2010, they started raising the dividend again, first to $0.48, then $0.56,

$0.60, $0.68, and now to $0.76 per year.

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Altria (blue chip) Current market price is $34.38 (15 Feb 2013) Currently paying $1.76 annual dividends Assume dividends also growing around 8% per year

Same required rate of return of 13% ($1.76 * 1.08) / (13% - 8%) = $1.901 / 5% $38.02 What a buy! Better than a 13% rate of return!

If you ignore the potential tobacco related lawsuit damage And that tobacco kills 400,000 Americans each year…

Using this model, investors are currently requiring approximately a 13.53% required rate of return ($1.76 * 1.08) / (13.53% - 8%) $34.38 ($34.37 actually)

(continued)

Would you buy Altria?Hey!

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Dividend Discount Models Constant Perpetual Growth Model (continued)

The Constant Perpetual Growth Model is very sensitive to the assumed growth rate of dividends The recent dividend growth rates of Coke, Altria,

P&G, and J&J are all currently higher than 8% Altria is 8.2%, Coke is 8.5%, J&J is 8.7%, and P&G is 9.7%!

But the model does not work if the required rate of return is equal to or less than the dividend growth rate (You get division by zero or negative prices) Therefore, we should actually raise our expected rates of

returns for all of these companies! All are actually much better buys than what the model

is telling us for our 10% or 13% rates of return

(continued)

Note: These are blue chip companies with long histories of rising dividends. But they are not alone. Check out ExxonMobil, McDonald’s, United

Technologies, Honeywell, 3M, Johnson Controls, and Yum Brands.

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Constant Growth Model Assume dividends will continue to grow at a

specified rate for a specified number of years

This model takes the Constant Perpetual Growth Model one step further, adding a term to account for constant growth for a number of years Just as the Constant Perpetual Growth Model evolved from

the Zero Growth Model, adding an additional term to account for the constant growth of dividends

(continued)

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¡Aye, Paquito! Do we have to

know how to do this?! (No.)

Dividend Discount Models

Constant Perpetual Growth Model

Added term to account for growth for a number of years

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Dividend Discount Models Two-Stage Dividend Growth Model

a.k.a. Variable Growth Model Assume dividends will continue to grow at a

specified rate into the future (presumably the fast-growth stage) and then grow at a second (presumably slower growth rate once the company matures)

(continued)

This model may look very impressive, especially to those who love math, but it has some serious problems. It is very difficult to accurately predict future

dividend growth during the initial fast growth stage of a stock. Usually companies do not pay significant dividends while they are growing quickly.

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Many decades ago, Benjamin Graham

warned against using overly sophisticated

mathematical models to value stocks.

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Dividend Discount Models Observations of the Dividend Discount Models

How do you use them for a company that isn’t paying any dividends? The simple answer is, “You can’t!”

Constant perpetual growth is usually an unrealistic assumption (except for a very small number of companies)

Dividend growth rates are very difficult to estimate With large cap, well-established companies,

historical growth rates may be useful But with fast growing companies in new industries, it

is almost impossible

(continued)

The problems of DDMs notwithstanding, repeat after me: “The value of a stock is based on the present value of its future cash flows.”

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Discounted Cash Flow Model Uses present value of expected dividends and

the present value of the expected future price to value a share of stock Also called the Dividends & Earnings Model (?) Value of stock = present value of future dividends +

present value of the price of stock when we plan to sell We use the present value multipliers from the table Not covered specifically in our text

But it is really just the pure form of the DDM with the present value of the expected price of the stock as our final cash inflow

As with the other DDMs, this model is very sensitive to our estimates and our choice of required rate of return and, hence,

can be very far off the mark.

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Discounted Cash Flow Model Example 1:

Assume it is January 1, 2013. Pretzels Unlimited is currently selling for $22 per share and will pay $2.00 per share in dividends in 2013. PU expects to increase their dividends to $2.20 in 2014, $2.30 in 2015, and $2.30 in 2016. We will be selling the stock at the end of 2016 and we expect the price to be $27 per share at that time. Our required rate of return is 12%.

Value of stock = present value of future dividends + present value of price of stock when you plan to sell Value = ($2.00*0.893)+(2.20*0.797)+(2.30*0.712)+(2.30*0.636)

+ ($27.00*0.636) =

= [ $1.786 + $1.7534 + $1.6376 + $1.4628 ] + $17.172 = = $6.6398 + $17.172 = $23.8118 $23.81

(continued)

If our required rate of return is 12%, this is a pretty good stock to buy.

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Pretzels Unlimited in Table Format

(continued)

Here is the problem in spreadsheet format. I think it is much easier to comprehend and calculate in this format, yes?

Years Cash Flows PVM12% Discounted Cash Flows

2013 $2.00 0.893 $1.786

2014 $2.20 0.797 $1.7534

2015 $2.30 0.712 $1.6376

2016 $2.30 0.636 $1.4628

2016 $27.00 0.636 $17.172

Total Present Value: $23.8118 $23.81

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Discounted Cash Flow Model Example 1 (Simplified):

Pretzels Unlimited in a More Simplified Table Format

(continued)

Adding the dividend and the stock price in the last year saves us a couple of manual calculations but more importantly, it also allows us

to use a special spreadsheet function to calculate …

Years Cash Flows PVM12%

Discounted Cash Flows

2013 $2.00 0.893 $1.786

2014 $2.20 0.797 $1.7534

2015 $2.30 0.712 $1.6376

2016 $2.30 + $27 = $29.30 0.636 $18.6348

Total Present Value: $23.8118 $23.81

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Discounted Cash Flow Model Internal Rate of Return (a.k.a. IRR)

The Internal Rate of Return is a measure of what rate of return we expect to get from a series of cash flows, including positive and negative flows Someday, when you take an upper-level or

graduate finance or investment class, you will learn how to manually compute Internal Rate of Return Hopefully, you will not have a sadistic professor who will

require you to calculate it manually more than once! We are simply going to enter the numbers into a

spreadsheet formula and press , okay?

(continued)

In other words, we required a 12% rate of return from Pretzels Unlimited, but what do our numbers tell us will be our expected rate of return?

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Internal Rate of Return (a.k.a. IRR), continuedThe spreadsheet formula is:

=IRR(values,approximate-rate-of-return) where values is the block of cells containing the cash flows, both

positive and negative, and approximate-rate-of-return is our guess as to what the

Internal Rate of Return will be

(continued)

Let’s take a look at the example spreadsheet on the class web page …

Year Cash Flows Comments

$ (22.00) Our initial outlay is $22.00 – enter any outflows as negative numbers

2013 $ 2.00 $2.00 dividend – enter cash inflows as possible numbers

2014 $ 2.20 $2.20 dividend

2015 $ 2.30 $2.30 dividend

2016 $ 29.30 $2.30 dividend + $27.00 proceeds from sale of stock

14.51% Internal Rate of Return =IRR(B2:B5,0.12)

Discounted Cash Flow Model

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Genes ’R’ Us (symbol GRUS) is currently selling for $21 per share. It pays no dividend. We believe that GRUS will sell for around $50 per share in five years. Our required rate of return is 13%. How can we determine if this is a good investment?

With no dividends, which model can we use? The Discounted Cash Flow Model can still be used!

Value of stock = present value of future dividends + present value of price of stock when you plan to sell

Value = $0.00 (from dividends) + ($50.00*0.543) = $27.13

(continued)

Unlike the other DDM’s, the Discounted Cash Flow Model can still be used if there are no dividends. Very cool!

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Residual Income Model Another method that is a cousin of the DDMs is

the Residual Income Model As with the Discounted Cash Flow Model, it allows

us to value a company that is not paying dividends Instead of using dividends, the model uses

earnings It is very similar to the Constant Perpetual Growth

Model We’ll skip it for now and maybe come back to it

later I think you have enough on your plate as it is … Ditto for all the other models described in chapter 6The Residual Income Model is covered in the 4th, 5th, and 6th

editions of the text but not in the 3rd edition.

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Okay, Paiano, this is all great, but just where are we supposed to get all this historical information, anyway? And just who decides what next year’s earnings per share, sales per share, cash flow per share, dividends per share, etc., etc., etc. are going to be, let alone the expected price of a stock in 3 to 5 years?! Before the Internet (BI?), this information was not

readily available Normally, you would ask your broker for it Or you would use one of the securities industry’s

trusted information sources Traditionally, the most respected source was …

Sources of Information

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Still one of the most respected and trusted sources of data and analysis Traditionally, it was often the only source many

investors used for data and analysis Along with the company’s materials

Expensive ($598 per year print edition, $538 online www.valueline.com), but can be obtained for free at the library

I am a big fan of Value Line, especially their Timeliness and Safety indicators.

One study (which ignored transaction costs and tax consequences) only used their Timeliness indicator. It showed how you would have beaten

the market handsomely over a twenty year period by just buying and selling stocks as they received and lost their #1 Timeliness designation.

The Value Line

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Can you find… The Value Line indicators? The future price projections? The historical data? The cash assets, receivables, inventory, and

other assets? The description and analysis of the business? The historical annual rates? The insider and institutional buying & selling? The amount of debt and number of shares

outstanding? The company’s financial strength, stability, price

growth, and earnings predictability ratings?

Value Line Example: McGraw-Hill, Page 206 (6th edition)

The Value Line(continued)

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(continued)The Value Line

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The Value Line Let’s put The Value Line to the test

In late 2009, the price of McGraw-Hill was $28.73 Their price prediction for early 2013 was in the range

from around $48 to $68 On February 15th, 2013, McGraw-Hill’s price closed

at $44.95 Not too bad, eh? Actually, pretty darned good!

When they made this prediction at the end of 2009, the stock market had rallied from the depths of the 2008/2009 crisis but many people were still predicting the end of the world By the way, some of them are still predicting the end of the world

(continued)

Now let’s look at The Value Line prediction for McGraw-Hill from the 4th edition

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The Value Line How did they do in mid-2005?

Their price prediction for late 2009 was in the range from around $66 to around $82 Aye! McGraw-Hill’s price was hovering around $24

in late 2009 What happened?

It reached $70 in mid-2007 and started falling as the credit markets started reacting to the home mortgage loan crisis McGraw-Hill owns Standard & Poors (Uh, you’ve heard of them)

It then plummeted as the home mortgage loan crisis spread to the entire financial sector in 2008 & 2009

Their mid-2007 prediction from the 5th edition of the text was even uglier!

(continued)

But what about their early-2003 prediction from the 3rd edition?

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The Value Line In early 2003, The Value Line predicted that

the price of McGraw-Hill would be around $90 to $110 in 2005 & 2006 (Why so much higher? McGraw-Hill split their

stock 2 for 1. You have to divide these prices by 2 to compare them to the previous two predictions.)

Hurray for The Value Line! They were bang on the money! McGraw-Hill

reached the $120 level by the end of 2006 ($60 split adjusted)

(continued)

I get a kick when some investors trash The Value Line. They make mistakes, too, just like everybody else. But I would sure love to see how those investors’ long-term results stack up against the long-term results

of The Value Line! Who do you think would have the better results?

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CHAPTER 6 – REVIEW

Common Stock Valuation

Next week: Chapter 17, Projecting Cash Flow and Earnings (Ratio Analysis)

Chapter Sections:Security Analysis: Be Careful Out ThereThe Dividend Discount ModelThe Two-Stage Dividend Growth ModelThe Residual Income ModelThe Free Cash Flow ModelPrice Ratio AnalysisAn Analysis of the McGraw-Hill Company

1 c hapter 6 common stock valuation chapter sections: security analysis: be careful out there the...

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