Stock valuation

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Chapter 8
Stock Valuation
T Outline
Learning Goals
I. Valuation: Obtaining a Standard of Performance A) Valuing a Company and Its Future 1. Forecasted Sales and Profits 2. Forecasted Dividends and Prices a. Getting a Handle on the P/E Ratio b. A Relative Price/Earnings Multiple c. Estimating Earnings Per Share d. Pulling It All Together B) Developing an Estimate of Future Behavior C) TheValuation Process 1. Required Rate of Return Concepts in Review II. Stock Valuation Models A) The Dividend Valuation Model 1. Zero Growth 2. Constant Growth a. Applying the Constant-Growth DVM 3. Variable Growth a. Applying the Variable Growth Dividend Valuation Model 4. Defining the Expected Growth Rate B) Some Alternatives to the DVM 1. Dividends-and-Earnings Approach 2. Finding the Value ofNon-Dividend Paying Stocks 3. Determining Expected Return 4. The Price/Earnings (P/E) Approach C) Other Price Relative Procedures 1. A Price-to-Cash-Flow (P/CF) Procedure 2. Price-to-Sales (P/S) and Price-to-Book-Value (P/BV) Ratios Concepts in Review


Gitman/Joehnk • Fundamentals of Investing, Ninth Edition

Putting Your Investment Know-How to the Test Discussion Questions ProblemsCase Problems 8.1 Chris Looks for a Way to Invest His New Found Wealth 8.2 An Analysis of a High-Flying Stock Excel with Spreadsheets Trading Online with OTIS

T Key Concepts
1. 2. 3. 4. 5. 6. 7. The role a company’s future prospects plays in the stock valuation process and a framework for developing such forecasts. Developing a forecast of a stock’s expected cash flow, starting with corporatesales and earnings and then moving to expected dividends and share prices. The concept of intrinsic value as a standard of performance, and its use in judging the investment suitability of a share of common stock. Valuation of a stock using zero growth, constant growth, and variable growth dividend valuation models. Other stock valuation models: Dividend and Earnings and IRR approaches. Pricerelative measures, including price/earnings, price/cash flow, price/sales, and price/book value. Understanding that different valuation models work in different instances depending on the payment of dividends and earnings persistence.

T Overview
The topics of stock valuation and security analysis are further considered in this chapter. It is basically a continuation of the discussion in thepreceding chapter. Also addressed are some major changes taking place in the market, as they affect the valuation process. 1. After analyzing a company’s performance to date, the investor projects the company’s future performance. Basic performance projections are related to the sales and profits of the company, subject to various economic and industry projections. Next, estimates of future dividendsand stock prices are obtained. Using the example in the text, the instructor should stress the usefulness and limitations of historical growth rates in obtaining estimates of the future.

Chapter 8

Stock Valuation



The P/E ratio is then extensively discussed, including the relationship between a company’s P/E ratios and the market’s P/E. This ratio is shown to be a function ofthe growth of the firm, the risk associated with that growth, and P/E ratios in the marketplace. Next comes the discussion of various types of stock valuation models. First presented is the dividend valuation model as a theoretically sound approach to apply to common stocks. The model requires a forecast of the next return, which is a function of risk and alternative returns. In this regard, theCAPM is reintroduced at this point to show how CAPM can be used to establish the required rate of return. Three types of dividend valuation models are introduced: zero growth, constant growth, and variable growth models. The dividends-and-earnings approach and the P/E approach are then shown as alternatives to the dividend valuation approach. This model is based on the present value of the stock’s...
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