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lecture_3 notes.docx

3 Pages
Fall 2011

Administrative Studies
Course Code
ADMS 3531

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Personal Investment Management
ADMS 3531 - Fall 2011 – Professor Dale Domian
Lecture 3, Part 2 – Common Stock Valuation – Sept 27
Chapter Seven Outline
-Security analysis.
-The dividend discount model.
-The two-stage dividend growth model.
-The residual Income Model.
-Price ratio analysis.
Common Stock Valuation
-Our goal in this chapter is to examine the methods commonly used by financial analysts
to assess the economic value of common stocks.
-These methods are grouped into two categories:
oDividend discount models.
oPrice ratio models.
Security Analysis
-Fundamental analysis is a term for studying a companys accounting statements and other
financial and economic information to estimate the economic value of a company’s stock.
-The basic idea is to identify ‘undervalued stocks to buy and ‘overvalued stocks to sell.
In practice however, such stocks may in fact be correctly priced for reasons not
immediately apparent to the analyst.
The Dividend Discount Model
-The dividend discount model (DDM) is a method to estimate the value of a share of stock
by discounting all expected future dividend payments.
Estimating the Growth Rate
-The growth rate in dividends can be estimated in a number of ways.
oUsing the company’s historical average growth rate.
oUsing an industry median or average growth rate.
oUsing the sustainable growth rate.
The Sustainable Growth Rate
-Sustainable growth rate = ROE [x] Retention Ration

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Personal Investment Management ADMS 3531 ­ Fall 2011 – Professor Dale Domian Lecture 3, Part 2 – Common Stock Valuation – Sept 27 Chapter Seven Outline ­ Security analysis. ­ The dividend discount model. ­ The two­stage dividend growth model. ­ The residual Income Model. ­ Price ratio analysis. Common Stock Valuation ­ Our goal in this chapter is to examine the methods commonly used by financial analysts  to assess the economic value of common stocks.  ­ These methods are grouped into two categories: o Dividend discount models.  o Price ratio models. Security Analysis ­ Fundamental analysis is a term for studying a company’s accounting statements and other  financial and economic information to estimate the economic value of a company’s stock.  ­ The basic idea is to identify ‘undervalued’ stocks to buy and ‘overvalued’ stocks to sell.  In practice however, such stocks may in fact be correctly priced for reasons not  immediately apparent to the analyst. The Dividend Discount Model ­ The dividend discount model (DDM) is a method to estimate the value of a share of stock  by discounting all expected future dividend payments. Estimating the Growth Rate ­ The growth rate in dividends can be estimated in a number of ways. o Using the company’s historical average growth rate. o Using an industry median or average growth rate. o Using the sustainable growth rate. The Sustainable Growth Rate ­ Sustainable growth rate = ROE [x] Retention Ration ­ Sustainable growth rate = ROE [x] (1 – Payout Ratio) ­ Return on Equity (ROE) = Net Income / Equity.  ­ Payout Ration = Proportion of earnings paid out as dividends. ­ Retention Ratio = Proportion of earnings retained for investment. The Two­Stage Dividend Growth Model ­ The two­stage dividend growth model assumes that a firm will initially grow at a rate 1   for T years, and thereafter grow at a rate2g  
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