ch09 Fin202
ch09 Fin202
ch09 Fin202
Chapter 9
Stock Valuation
Copyright ©2022 John Wiley & Sons, Inc.
Chapter 9: Stock Valuation
• Secondary markets
• Major secondary markets
• Efficiency of secondary markets
• Stock market indexes
• Reading stock market quotes
• Least efficient
o A buyer and seller must find each other without assistance. A
search among all possible partners to locate the best price is
seldom done
o Transactions are so infrequent that no third party (broker or
dealer) has incentives to serve the market
o Is the least efficient market - farthest from the ideal that provides
complete price information
• Most common instances where direct search is used:
o Sale of small private firm’s common stock
o Private placement of common stock
• The Wall Street Journal, The New York Times, and other
major newspapers provide stock listings for the NYSE,
NASDAQ, and relevant regional exchanges
• Stock price quotes and other market information are also
readily available online from reliable websites such as
Yahoo! Finance, MSN Money, and CNBC, just to name a
few
• Common stock
• Preferred stock
• A one-period model
• A perpetuity model
D1 P1
P0
1 R
D1 D 2 P2
P0
1 R 1 R
1 2
D1 D2 D3 Dt Pt
P0
1 R 1 R 2 1 R 3 1 R 1 R
t t
• Here, t is the time period, which can be any number from one
to infinity (∞). We will use t, instead of n, to denote the time
period from this point forward because it is more commonly
used in pricing equations; n will still be used to denote the
number of periods.
∞
D𝑡
P0 =∑
𝑡 =1 ( 1+ R )𝑡
• Although theoretically sound, it is not practical to add an infinite
number of terms
• Equation 9.1 is a general model for valuing a share of stock
L.O. 9.4 Copyright ©2022 John Wiley & Sons, Inc. 28
Details of the Dividend Valuation
Model
• The value of a share of stock is the present value of all
expected future cash dividends. The model
o Requires dividend forecasts for an infinite number of
periods
o Implies the intrinsic value of a share of stock is determined
by the market’s expectations of a firm’s future cash flows
• The model does not include specific assumptions, such as:
o Whether the growth rate is constant, which is important in
estimating expected future cash dividends
o Forecasting dividends or when a share of stock might be
sold
L.O. 9.4 Copyright ©2022 John Wiley & Sons, Inc. 29
Growth Stock Pricing Paradox
• Growth stock: stock of a company whose earnings are growing at an
above-average rate and are expected to continue to do so for some
time
• Rapidly-growing firms
o Typically pay no dividends on common stock in the growth phase
o Have many high-return investment opportunities, making investors are
better off if firms reinvest earnings
• But Equation 9.1 and common sense predict that the shares of a
company that will never pay cash to investors are worthless
o In reality, high-growth firms will eventually pay dividends
o If investments made with reinvested funds succeed, a firm’s net cash
inflows should increase significantly and investors can sell their stock at
a much higher price than what they paid
L.O. 9.4 Copyright ©2022 John Wiley & Sons, Inc. 30
9.5 Stock Valuation: Some Simplifying Assumptions
LEARNING OBJECTIVE
Discuss the assumptions that are necessary to make the general
dividend-valuation model easier to use, and use the model to compute
the value of a firm’s common stock
D
P0
R
D $5
P0 $25
R 0.20
D t D 0 1 g
t
D1 $5.00
P0 $35.71
R g 0.18 0.04
D6 $3.35
P5 $33.50
R g 0.15 0.05
Equation 9.6
D1 D2 Dt Pt
P0
1 R 1 R 2 1 R 1 R
t t
Exhibit 9.4 The exhibit shows a timeline for a nonconstant dividend growth
pattern. The timeline makes it easy to see that we have two different dividend
growth patterns. For three years, the dividends are expected to grow at a mixed
rate; after that, they are expected to grow at a constant rate of 6 percent.
D4 $3.18
P3 $35.33
R g 0.15 0.06
0.08
n 4 20 and i
4
D
P0
R
D $5
P0 $62.50
R 0.08