stock valuation 1
TRANSCRIPT
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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
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