The Value of Common Stocks

1
Lecture 4
The Value of Common Stocks
2
Topics Covered

• Dividend Discount Method
• Plowback/Payout Ratio
• Mini-cases
• Information and Stock Market
• Preferred Stocks Valuation
• Additional readings ch.6, 13.1 and 13.2 BM4,
  ch.4, 14. 2 BM

3
Terminology

• Common Stock
• Preferred Stock
• Book Value
• Liquidation Value
• Market Value
• Dividend

4
Stock Prices of some Canadian firms, 2001
5
Dividend Discount Model

• What would be the price of the firm A shares if
• Next years dividend (DIV1) will be 3.
• Dividends grow at 8 in perpetuity.
• The discount rate is 12.

6
DDM case 2 (Example 1)

• You expect XYZ stock to pay a 5.50 dividend at
  the end of the year. The stock price is expected
  to be 120 at that time. If you require a 15
  rate of return, what would you pay for the stock
  now?

7
DDM case 2 (Example 2)

• Current forecasts are for XYZ Company to pay
  dividends of 3, 3.24, and 3.50 over the next
  three years, respectively. At the end of three
  years you anticipate selling your stock at a
  market price of 94.48. What is the price of the
  stock given a 12 expected return?

8
Plowback/payout ratio

• plowback ratio.
• payout ratio.

9
Minicase PHS
10
Constant-Growth Scenario
11
Rapid-Growth Scenario
12
Stock Market
13
Equity Market Capitalization (Billion U.S.),
09/2000
USJapanUKFranceGermanyCanadaSwitzerlandNeth
erlandsItalySwedenAustraliaHong
KongMexicoKoreaTaiwanSouth AfricaSingaporeBr
azilGreeceMalaysia
10,5472,3941,9031,0147605435244883872722
441951091071039390886258
Source Merrill Lynch Global Economic Trends,
January 2001.
14
Asymmetric information
15
Evidence that managers delay bad news..
16
(No Transcript)
17
Example

• Xerox preferred pays 4.125 dividend per year.
  Suppose our required rate of return on Xerox
  preferred is 9.5. What is the share price?