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7/28/2019 VALUATION by Reynaldo Nograles (2)
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7/28/2019 VALUATION by Reynaldo Nograles (2)
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Q: Given the market price MPo of a common
stock in the market, how would an investor
know if this stock is worth buying or not?
A: The investor determines the INTRINSIC VALUE Po ofthis common stock and then compares this intrinsicvalue with the market price MPo. If Po>MPo => the stock is worth buying. If Po the stock is NOT worth buying(or the investor sells the stock ifhe/she already has it) If Po=MPo => the investor needs some othercriterion or basis for buying ornot buying the stock.
2
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WINTERTemplate
3STOCK VALUATION METHODS OR METHODS OF
DETERMINING THE INTRINSIC VALUE OF THE
COMMON STOCK OF A COMPANY:
PSEion thereturnofrateexpectedthe)E(R
stockcommonon therisksystematicthe
returnofratefree-riskthe
-)(
companytheROEoftheor
investortheofreturnofratedesiredthe
yeartheofendat thestocktheofpriceestimatedP
yeartheofendat thepaidbetoshareperdividendestimatedD:where
1
periodholdingyear1:1METHOD
M
1
1
110
f
fMf
R
RR
ERor
k
k
PDP
7/28/2019 VALUATION by Reynaldo Nograles (2)
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STOCK VALUATION METHOD
(cont inuat ion) 4
H
H
H
H
k1
P
k1
D
k1
D
k1
D
k1
DP
)()(...
)()(
d)whiteboaron the
diagramtimethe(showyearsHPeriodHolding:2METHOD
3
3
2
210
4
7/28/2019 VALUATION by Reynaldo Nograles (2)
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5
A plans to buy ABC Corp. common stocks now. Heprojects that ABC would pay annual dividends ofP5, P6 and P8 per share at the end of years 1, 2 and3, respectively, and that the price of the stock at the
end of year 3 would be P100 per share. A expectsthe rate of return on the PSEi to be 15% per year andthe risk free rate to be 6% p.a. The systematic riskon the stock is 1.5. If the stocks current market priceis P71 per share,
a) Calculate the intrinsic value of the stock.
b) Is the stock worth buying now? EXPLAIN.
ANSWER: a.) P0 = P71.674
WORKSHOP PROBLEM: (to be solved by
group after the presentation):
5
7/28/2019 VALUATION by Reynaldo Nograles (2)
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6STOCK VALUATION METHOD
(cont inuat ion)
stocks.commongfor valuin
DDMor theMODELDISCOUNTDIVIDENDtheisThis
)(...
)()(
:asdownwrittenbecan
2METHODunderPforequationthebig,infinitelyHIf
big)infinitelyH(i.e.,PeriodHoldingIndefinite:3METHOD
3
3
2
210
0
k1
D
k1
D
k1
D
k1
DP
6
7/28/2019 VALUATION by Reynaldo Nograles (2)
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WINTERTemplate7
N.B.: The DDM asserts that1. The intrinsic value P0 of a common stock
is equal to the PV of all expected future
dividends into PERPETUITY.
2. The intrinsic value P0 of a common stockis determined ultimately by the
DIVIDENDS that the stock would pay inthe future.
STOCK VALUATION METHOD
(cont inuat ion)
7/28/2019 VALUATION by Reynaldo Nograles (2)
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8STOCK VALUATION METHOD
(cont inuat ion)
+=......;+=
;+=+=;+=
yeartoyearfromconstant=
dividendstheofrategrowthannualthe=g
yearPREVIOUStheof
endtheatdividendtheordividendcurrentthe=
ModelSHAPIRO-GORDONtheorDDMGrowthconstantthe:4METHOD
3
3
2121
0
H
0H0
00
g)(1DDg)(1DD
g)(1Dg)(1DDg)(1DD
Dlet
8
7/28/2019 VALUATION by Reynaldo Nograles (2)
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9STOCK VALUATION METHOD
(cont inuat ion)
)2.4(
)(...
)(
:g1
k1by4.1EquationMultiply
)(...
)()(
:aswrittenbecanequationDDMThen the
1
1
2
2
00
3
3
2
2
0
Equation
k1g)(1D
k1g)(1D
k1g)(1DDP
g1k1
4.1)(Equation
k1
g)(1D
k1
g)(1D
k1
g)(1D
k1
g)(1DP
H
H
000
H
H
0000
9
7/28/2019 VALUATION by Reynaldo Nograles (2)
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10STOCK VALUATION METHOD
(cont inuat ion)
)1(
11
11
0)1(
)1(HwhenANDwhen
:4.2Equationfrom4.1EquationSubtract
10
00
000
gk
DPor
gk
gDPor
DPggkorDP
gk
k
g,gk
k)(1
g)(11DP1
g1
k1
ork)(1
g)(1DDPP
g1
k1
o
H
H
H
H
00
H
H
0
000
10
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11STOCK VALUATION METHOD
(cont inuat ion)
WORKSHOP PROBLEM FOR METHOD 4( to be solved by groupafter the presentation):Last year, ABC Corporation paid out dividends of P6 pershare and it is assumed that these dividends will grow annually at a
constant rate of 10%. It is expected that the rate of return on the PSEiwill be 20% p.a. and that the risk-free rate will be 5% p.a. If thesystematic risk on ABCs common stock is 1.2 and if its current marketprice is P54 per share,a.) determine the intrinsic value of the stock.b.) Is ABCs common stock worth buying? EXPLAIN.
ANSWER: P0 = P50.7711
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WINTERTemplate12
STOCK VALUATION METHOD
(cont inuat ion)
sharescommonoustandingNo.of
sliabilitieassetsofvaluerealizableNetshareperNAV
MethodNAVThe:5METHOD
N.B.:1. This method is commonly used to value the common stocks of
real estate development companies like ALI, Megaworld, FLI,
etc.
2. The method is most suitable for valuing the common stocks of acompany that is under LIQUIDATION.
7/28/2019 VALUATION by Reynaldo Nograles (2)
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13STOCK VALUATION METHOD
(cont inuat ion)
00 EPSxPERAVERAGEP
Method(PER)RatioingsPrice/EarnThe:6METHOD
where:PER = price/earnings ratio = market price as of the end of agiven year EPS or earnings per share at the end of that
year
EPS at the end of any given year= net income after tax duringthe given year No. of outstanding common shares as of endof that year
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14where:AVERAGE PER = the average PER of the company
during the LAST SEVERAL YEARS or the PER ofthe SECTOR or INDUSTRY to which the company
belongs
EPS0= the current earnings per share of thecompany or the earnings per share at the end of
the PREVIOUS YEARN.B.: Pause for 15 seconds to allow Method 6 to sink in!
STOCK VALUATION METHOD
(cont inuat ion)
14
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15STOCK VALUATION METHOD
(cont inuat ion)
Notes on the PER:1. The PER of a common stock may be interpreted as the numberof pesos that the investor would be willing to pay for everypeso of net income that the common stock earns.
2. The PER of a common stock is NOT CONSTANT; it changes
from year to year
3. The FORWARD PER of a common stock (i.e., the stocks PER oneyear from now) may be obtained by dividing the stocks currentintrinsic value by the estimated EPS at the end of that one year;that is,
1
0
EPS
PPERFORWARD
15
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16STOCK VALUATION METHOD
(cont inuat ion)
4.) Under the GORDON-SHAPIRO Model, the FORWARD PERis given by
)3.4(g-k
b-1
g-k
-1
g-kg-k
g-k
/1
g-k
1
1
1
11
1
1
10
1
0
EquationPERFORWARDor
YEARFORWARDTHEOFENDTHEATRATEPLOWBACKEXPECTED
EDPRYEARFORWARDTHEOFENDTHEATRATIOPAYOUTDIVIDENDEXPECTED
EPSD
EPS
D
EPSP
EPS
PPERFORWARD
16
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WINTERTemplate17
STOCK VALUATION METHOD
(cont inuat ion)
5.) After obtaining the value of the FORWARD PERfrom Equation 4.3, this value may be used toESTIMATE the price P1 of the common stock atthe end of the forward year; that is,
gEPSgkb
xEPSgk
b
EPSxPERFORWARDP
11
1
01
11
11
7/28/2019 VALUATION by Reynaldo Nograles (2)
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18STOCK VALUATION METHOD
(cont inuat ion)
WORKSHOP PROBLEM FOR METHOD 6( to be solved by groupafter the presentation):ABC Corporation pays annual common stock dividendsthat grow or increase at a constant rate of 10% per year. Duringthe current year, ABC paid dividends of P8 per common share. Bythe end of year 1, it is estimated that ABC will earn P70 percommon share, 85% of which would be retained by the company.It is expected during year 1 that the rate of return on the PSEi wouldbe 15% and that the risk-free rate would be 6% p.a. It is alsoknown that the systematic risk on the stock is 1.5.a) Determine the intrinsic value of the stockb) If the current market price of the stock is P95 per share,is the stock worth buying now or not?c) Estimate the price of the stock at the end of year 1.ANSWERS: P0 = P92.632; P1 =P110.526
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19STOCK VALUATION METHOD
(cont inuat ion)
EBITDA
EVorValueEnterpriseEMMULTIPLEENTERPRISE
Method(EM)MULTIPLEENTERPRISEThe:7METHOD
where:EV = Market Capitalization + LT debts Cash equivalents Marketable or Tradeable Securities or Investments
Market Capitalization = current market price of the common stock xNo. of outstanding common shares
EBITDA = Earnings before INTEREST, TAXES, DEPRECIATION andAMORTIZATION
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20STOCK VALUATION METHOD
(cont inuat ion)
NOTES ON METHOD 7 (EM Method):1) The method takes into account the LT debts of the company
2) The method is more appropriate for comparing companieshaving operations in different countries because it does not
consider the distorting effects of international taxation policiesand depreciation practices
3) The method can be used even for companies that incur andreport net losses
4) A LOW EM compared to other companies in the same industryindicates that the company is UNDERVALUED which can be abasis for BUYING THE company.
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21STOCK VALUATION METHOD
(cont inuat ion)
INTERMISSION (before going to METHO D 8):DETERMINING THE WEIGHTED AVERAGE COST OF CAPITAL orWACC OF A COMPANYSTEP 1: Obtain the cost KPS of preferred stocks, the cost KCS ofcommon stocks and the cost KLTD of LT debts.
STEP 2: Calculate the WACC using as weights the proportions ofpreferred stocks, common stocks and LT debts to the TOTAL CAPITALof the company;i.e., WACC = WPSKPS + WCSKCS + WLTDKLTD (1-CITR)N.B.:1. WPS, WCS AND WLTD should be in decimals and their sum should
be equal to 1; i.e., WPS + WCS+ WLTD = 12. The values of KPS, KCS, KLTD may be left in PERCENTAGES.3. CITR = the corporate income tax rate of the company
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WINTERTemplate22
DETERMINING THE COST OF
PREFERRED STOCK (KPS)
WHERE:DPS = the annual AMOUNT of dividend PER
SHARE on the preferred stock
NPS = the NET PROCEEDS PER SHARE fromthe sale of the preferred stock= selling price per share of the preferredstock underwriting or flotation expenseper share
PS
PS
PSN
DK
7/28/2019 VALUATION by Reynaldo Nograles (2)
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23DETERMINING THE COST OF
COMMON STOCK (KCS)
gMP
DKk
gP
Dk
kforSolving
D
RRERk
CS
fMf
0
1
00
0
1
10
CS
:stocktheof)(MPpricemarketcurrentthebyPREPLACING
:
g-kP
:equationSHAPIRO-GORDONtheUsing:BMethod.)2
-)(K
:CAPMtheUsing:AMethod.)1
23
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24STOCK VALUATION METHOD
(cont inuat ion)
3
3
2
2T
T
)(
....
)()(V
is,thatrate;discounttheas
WACCscompany'theusingsOFCF'or
FLOWSCASHFREEOPERATINGANNUALthegdiscountin
byenterpriseorcompanyENTIRE
theofVuemarket valObtain the:1STEP8.1)
:STEPS
:Method(DOFCF)FLOWCASH
FREEOPERATINGDISCOUNTEDThe:8METHOD
WACC1
OFCF
WACC1
OFCF
WACC1
OFCF
WACC1
OFCF1
24
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25STOCK VALUATION METHOD
(cont inuat ion)
WHERE:OFCFt = the EXPECTED operating free cash flowat the end of the year t
= the amount of cash flow available to
investors (i.e., the shareholders and theproviders of LT debts or creditors) afterthe company has set aside allamounts or monies needed for
operation and to pay for thecompanys investments in fixed assetsand current assets.
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26METHOD 8: THE DISCOUNTED OPERATINGFREE CASH FLOW METHOD (CONTINUATION)In practice, VT is obtained by using an equation
which is homologous to the GORDON-SHAPIROMODEL equation for obtaining the intrinsic value Po. Thisequation for VT is
Where:OFCFo = the opeating free cash flow at the end
of the current year.g = the constant annual growth rate of the
OFCFs
gWACC
gOFCFV OT
)1(
26
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27METHOD 8: The DISCOUNTEDOPERATING FREE CASH FLOWMethod (continuation)8.2) STEP 2: Determine the market value VLTD of
all the companys LT debts.
8.3) STEP 3: Determine the market value VPS ofthe companys preferred stocks
8.4) STEP 4: Obtain the market value VCS of thecompanys common stocks;i.e., VCS = VT VLTD VPS
8.5) STEP 5: Determine the intrinsic value P0 of thecompanys common stocks;i.e.,
sharescommongoutstandinofNo.
V=P
CS
o
27
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28STOCK VALUATION METHOD
(cont inuat ion)
WORKSHOP EXERCISE FOR METHOD 8:The end-of-year operating free cash flow for theCURRENT YEAR of ABC Corporation is 600,000Php
and this cash flow is projected to GROW AT ACONSTANT RATE of 3% p.a. The market value of all thecompanys LT debts is 3.1MPhp while the market valueof its preferred stocks is 800,000Php. The companysWACC is 9% p.a. If the company issued 1M outstandingcommon shares, find the intrinsic value per share ofthese common stocks. (Answer: 6.40Php)
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