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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 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.

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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