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Chapter 7

CFIN501- Chapter 7- Common Stock Valuation.docx

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Department
Finance
Course
FIN 501
Professor
Edward Blinder
Semester
Spring

Description
CFIN501 Chapter 7 Common Stock ValuationSecurity Analysis Be Careful Out ThereBasic ideaidentify undervalue or cheap stocks to buy over valued or rich to sellMany stocks that look cheap may be in fact price correctlyGood analyst cautious attitude and a willingness to probe further and deeper before committing to a final investment recommendationFundamental analysisexamination of a firms accounting statements and other financial and economic information to assess the economic value of a companys stockoEarnings per share cash flow book equity value and salesoDescribe specific firms operations and profitsoRepresents the examination of these and other accounting statement based company data used to assess the value of a companys stockoManagement quality products and product markets is examined as wellToo simple techniques that rely on widely available information are not likely to yield systematically superior investment resultsoOrdinary investors who do not have timely access to the information that a professional security analyst working for a major securities firm would possessThe Dividend Discount ModelFundamental principle of financeeconomic value of a security is properly measured by some of its future cash flowsoCash flow adjusted for risk and the time value of moneyDividend discount model DDMmethod of estimating the value of a share of stock as the present value of all expected future dividend paymentsk12k13k1D1D2V01koDtdividend to be paid t years from now oV0present value of the future dividend streamokappropriate riskadjusted discount rate Constant Perpetual GrowthParticularly simple form of the dividend discount model occursfirm will pay dividends that grow at the constant rate g foreverD01gV0gkkgSince D01gD1 write the constant perpetual growth modelD1V0gkkgConstant perpetual growth model requires that the growth rate be strictly less than the discount rare gkoShare value would be negative if this were not trueoPerpetual dividend growth rate greater than a discount rate implies an infinite valuepresent value of the dividend keeps getting bigger and biggerNo security can have infinite valuerequirement that gk simply makes good economic senseHow to we get the formula for constant perpetual growth1
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