Investment PlanningValuation of a Firm

April 16, 2015

Vandana Srivastava

Valuation of a Firmbased on economic factors, industry variables, an

analysis of the financial statements and the outlook of the firm

determines the long-run fundamental economic value of the firm’s common stock

process determines if the stock is undervalued, overvalued or fairly-valued relative to its market price

Basic Valuation Modelsdividend valuation model

◦based on dividends expected to be received during the future

◦ interprets value of a share of a stock as present value of an expected stream of future dividends

earnings valuation model◦assumes earning to be the main source of

income

Dividend Model: Constant Growth Model

assumes that dividends will increase at a constant growth rate (less than the discount rate) forever. The valuation is given by the formula:

cost of equity: shareholder's required rate of return on an equity investment; k = rf + β (rm – rf)

best suited for companies in the expansion or maturity life-cycle phase

accuracy of the stock price depends on the inputs

Where:Po is the share price at the present timeDo is the most recent dividend (full year dividend)g is the sustainable dividend growth rate of the companyk is the cost of equity of the company or required rate of return

http://www.investinganswers.com/financial-dictionary/stock-valuation/cost-equity-2476

Earnings Valuation Model: EPS

take the present value of all future earnings to determine a value

appropriate for companies not paying cash dividends presently and immediate future

if estimated stock price > market price of the stock => stock is undervalued and vice-versa

Example: Combined Earnings and Dividend ModelPART A

Estimated EPS (a)

Estimated Payout Ratio

(b)

Estimated DPS

PV of Cash Flows (at

12% value 1 2007 4.10 0.36 1.48 1.32

2 2008 4.51 0.36 1.62 1.29

3 2009 4.96 0.36 1.79 1.27

4 2010 5.46 0.36 1.96 1.25

5 2011 6.00 0.36 2.16 1.23

6.36(a) : assumed to be growing at 10% from 2007 to 2011(b) given by DPS/EPS; firm's payout ratio fluctuated between 34% to 39% from 1997 to 2006

PART BEstimated

EPS (a)P/E Ratio *

Price in 2011

PV of 2007 price (at

12% value of K) 1

5 2011 6.00 20.00 120.00 68.0968.09

PV of estimated dividends

PV of stock in 2007 = part A + part B = $74.40

* historical average P/E was 23 and its growth rate was slowing in the previous periods so lower P/E is a reasonable estimate

Target Pricea projected price level as stated by an

investment analyst or advisoror

a price that, if achieved, would result in an investor recognizing the best possible outcome for his or her investment

better than “ratings” as:◦ ratings are opinions of individuals / analyst

which may not be applicable to every investor

Example: Apple (yahoo! finance)

Calculate Target PricePrice x ((current P/E) / (forward P/E)) = future

price (or price target)

forward P/E is the measure of the price-to-earnings ratio (P/E) using forecasted earnings for the P/E calculation.

Topic of Discussion!

principle of net neutrality:what is net neutrality?which companies / industry would be

affected by it?will it have any impact on stock market?

how?

Reference

“Fundamentals of Investment Management” by Hirt and Block

investopedia