Stocks and Their Valuation
Stocks and Their Valuation
Stocks and Their Valuation
CHAPTER 9
Stocks and Their Valuation
Represents ownership.
Ownership implies control.
Stockholders elect directors.
Directors select management.
Management’s goal: Maximize stock
price.
Copyright © 2001 by Harcourt, Inc. All rights reserved.
9-3
Social/Ethical Question
D1 D2 D3 D
Pˆ0 ...
1 r s 1 r s 1 r s 1 r s
1 2 3
D1 = D0(1 + g)1
D2 = D0(1 + g)2
Dt = Dt(1 + g)t
If g is constant, then:
^ D0(1 + g) D1
P0 = = .
rs - g rs - g
Copyright © 2001 by Harcourt, Inc. All rights reserved.
9 - 21
D1
Pˆ0 requires rs g.
rs g
If rs< g, get negative stock price, which is
nonsense.
We can’t use model unless (1) rs> g and (2) g is
expected to be constant forever.
D1
Pˆ0
rs
Example
(More...)
Copyright © 2001 by Harcourt, Inc. All rights reserved.
9 - 35
^
rs = D1/P0 + g = rs = rRF + (rM – rRF)b.
Copyright © 2001 by Harcourt, Inc. All rights reserved.
9 - 38
^
rs = D1/P0 + g = rs = rRF + (rM – rRF)b.
Copyright © 2001 by Harcourt, Inc. All rights reserved.
9 - 39
^ D1
If rs = + g > rs, then
P0
^ D1
P0 =
ri – g
1. ri could change:
ri = rRF + (rM – rRF )bi.
rRF = r* + IP.
1. Weak-form EMH:
Can’t profit by looking at past trends.
A recent decline is no reason to
think stocks will go up (or down) in
the future. Evidence supports
weak-form EMH, but “technical
analysis” is still used.
2. Semistrong-form EMH:
All publicly available information is
reflected in stock prices, so
doesn’t pay to pore over annual
reports looking for undervalued
stocks. Largely true, but superior
analysts can still profit by finding
and using new information.
3. Strong-form EMH:
All information, even inside
information, is embedded in stock
prices. Not true--insiders can gain
by trading on the basis of insider
information, but that’s illegal.
Preferred Stock
Hybrid security.
Similar to bonds in that preferred stockholders
receive a fixed dividend that must be paid
before dividends can be paid on common stock.
However, unlike interest payments on bonds,
companies can omit dividend payments on
preferred stock without fear of pushing the firm
into bankruptcy.
rp D / Vp
$5
rp 0 . 10 10 . 0 %.
$ 50