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STOCKS &THEIR VALUATION
Presented By:
Tehmina Tabassum
Nimra Rasheed
Samiya Shahid
Javeria Khalid
Nabeela Sarfraz
MBA- 16
WHAT IS STOCK?
• Stock is a share in the ownership of a
company. Stock represents a claim on the
company's assets and earnings. As you
acquire more stock, your ownership stake
in the company becomes greater. Whether
you say shares, equity, or stock, it all
means the same thing.
DEBT
 Requires regular interest
payments.
 Must be repaid or
refinanced. Company must
generate cash flow to pay
 Interest payments are tax
deductible.
 Debt has little or no impact
on control of the company.
EQUITY
 No payment requirements.
May receive dividends, but
only out of retained
earnings
 Equity providers are
aggressive. They can
accept downside risks
because they fully share
the upside as well.
 Dividend payments are not
tax deductible.
 Equity requires shared
control of the company
and may impose
restrictions
TYPES OF STOCKS
• There are many different types of
stocks which can be invested in based
upon your financial position, your risk
comfort level, and your investment
goals. The basic two types of stock
are common stock and preferred
stock.
COMMON STOCK
• Common stock is the most typical type of
stock. In fact, the greatest number of stock
issued is in this form. Common shares
represent ownership in a company and a
claim (dividends) on a portion of profits.
Investing persons or firms get one vote per
stock share to elect the board members,
who oversee the major decisions made by
management.
PREFERRED STOCK
• Same as with common stock, preferred
stock represents some degree of ownership
in a company but typically doesn't come
with the same voting rights. With preferred
stock investors are usually guaranteed a
fixed dividend forever. This is different
than common stock, which has variable
dividends that are affected by the market
and never guaranteed.
INVESTMENT BANK
• Investment banks are organizations through
which companies can raise funds by selling
stakes (stock) of the company in exchange
for cash. In simpler terms, investment
banks 'take companies public' by acting as
middlemen; the investment bank provides
cash from investors for the company, and
in return provides new shares of that
company to those investors.
INVESTMENT BANK’S ROLE
IN EQUITY OFFERINGS
• SERVICES:
• Investment banks provide four primary
types of services. Services. Smaller
investment banks may specialize in two or
three of these categories :
 RAISING FUNDS
 ADVISING IN MERGERS
 EXECUTING SECURITIES TRADING
 GENERAL ADVISORY SERVICES
INVESTMENT BANK
SERVICES AND COST
COST :
With most fund-raising efforts, whether
they be through debt or equity the
investment bank keeps for themselves a
nominal percentage of the funds raised in
the underwriting process. The amount of
money retained as the underwriting fee can
range anywhere from 3% to 20% (or more)
depending on the risk or difficulty of the
fund-raising process.
SECONDARY MARKET
• The secondary market is trading in
securities after the initial issue the sale of
securities from one investor to other.
Unlike the primary market, in secondary
market investor can buy a security directly
from another investor without the need of
any issuing corporation.
NYSE
The most important secondary markets are
securities exchanges, such as stock
exchanges. NYSE is the largest exchange
in the world with almost 360 billion shares
listed. The NYSE is the first type of
exchange where much of the trading is
done face-to-face on a trading floor.
NASDAQ
The second type of exchange is the virtual sort
called an over-the-counter (OTC) market, of which
the NASDAQ is the most popular. These markets
have no central location or floor brokers
whatsoever. Trading is done through a computer
and telecommunications network of dealers. It
used to be that the largest companies were listed
only on the NYSE while all other second tier
stocks traded on the other exchanges
PREFERRED STOCK
DEFINITION
• It is a part of equity that is expected to pay
a fixed annual dividend to investor.
CHARACTERISTICS OF
PREFERRED STOCK
• Preferred stocks represent partial
ownership in a company
• A preferred stock pays a fixed dividend that
does not fluctuate
• Preferred shareholders always receive their
dividends first and, in the event the
company goes ruined, preferred
shareholders are paid off before common
stockholders
• Preferred stock shareholders do not enjoy
any of the voting rights
TYPES OF PREFERRED
STOCK
• Cumulative and non-cumulative preferred
stock
• Convertible preferred stock
• Participating preferred stock
• Redeemable preferred stock
DIFFERENCE BETWEEN
PREFERRED & COMMON STOCK
• Preferred stock don’t have voting right
while common stockholders do have
• Preferred stock is a stable investment.
• Common stock holder can seek the benefit
of higher dividend
• Preference over the common stock in case
of liquidation or payment of dividend
DIFFERENCE BETWEEN PREFERRED
STOCK & BOND
• They are junior to the company’s debt
obligations
• Unlike debt instruments, the company isn’t
legally obligated to make dividend
payments to its preferred stockholders
• Dividends don’t accrue between dividend
payment dates.
FACTORS EFFECTING
MARKET PRICE OF PS
• DIVIDEND
• RISK
• INTEREST RATE
VALUATION OF PREFERRED
STOCK
• It is calculated by the formula;
PS = D/r
• Ps = market price of the preferred stock
• D = next period`s dividend payment
• r = discount rate
DIVIDENDS
• A taxable payment declared by a company's
board of directors and given to its
shareholders out of the company's current
or retained earnings
CHARACTERISTICS OF
DIVIDENDS
• Dividends are not liability
• Dividend and taxes
• Firm cant go bankrupt
COMMON STOCK
COMMON STOCK
• A share of common stock represents an ownership
position in the firm. Typically, the owners are
entitled to vote on important matters regarding the
firm, to vote on the membership of the board of
directors, and (often) to receive dividends.
• In the event of liquidation of the firm, the common
shareholders will receive a share of the assets
remaining after the creditors (including
employees) and preferred stockholders have been
paid off. If the liquidation is bankruptcy related,
the common shareholders typically receive
nothing, though it is possible that they may receive
some small amount.
COMMON STOCK VALUATION
• As with any other security, the first step in valuing
common stocks is to determine the expected future
cash flows.
• Finding the present values of these cash flows and
adding them together will give us the value:

VCS
CFt

t


1

k
t 1
For a stock, there are two cash flows:
Future dividend payments
The future selling price
EXAMPLE
• Assume that you are considering the purchase of a
stock which will pay dividends of $2 (D1) next
year, and $2.16 (D2) the following year. After
receiving the second dividend, you plan on selling
the stock for $33.33. What is the intrinsic value of
this stock if your required return is 15%?
?
VCS 
33.33
2.16
2.00
2.00
1.15
1

2.16  33.33
1.15
2
 28.57
SOME NOTES
• In valuing the common stock, we have made two
assumptions:
– We know the dividends that will be paid in the
future.
– We know how much you will be able to sell the
stock for in the future.
• Both of these assumptions are unrealistic,
especially knowledge of the future selling price.
• Furthermore, suppose that you intend on holding
on to the stock for twenty years, the calculations
would be very tedious!
SOME ASSUMPTIONS
• We cannot value common stock without making
some simplifying assumptions. These assumptions
will define the path of the future cash flows so that
we can derive a present value formula to value the
cash flows.
• If we make the following assumptions, we can
derive a simple model for common stock
valuation:
– Your holding period is infinite (i.e., you will never sell
the stock so you don’t have to worry about forecasting a
future selling price).
– The dividends will grow at a constant rate forever.
• Note that the second assumption allows us to
predict every future dividend, as long as we know
the most recent dividend and the growth rate.
THE DIVIDEND DISCOUNT
MODEL
• With these assumptions, we can derive a model
that is variously known as the Dividend Discount
Model, the Constant Growth Model, or the Gordon
Model:
THE DIVIDEND DISCOUNT
MODEL
D 0 1  g
D1
VCS 

k CS  g
k CS  g
ESTIMATING THE DDM
INPUTS
• The DDM requires us to estimate the dividend
growth rate and the required rate of return.
• The dividend growth rate can be estimated in three
ways:
– Use the historical growth rate and assume it will continue
– Use the equation: g = br
– Generate your own forecast with whatever method seems
appropriate
• The required return is often estimated by using the
CAPM: ki = krf + bi(km – krf) or some other asset
pricing model.
FORMULAS TO BE USED IN
NUMERICAL
• Value of Preferred stock
Dividend per year Ps = Dp
Rate of return
ke
• Value Common stock = p₀
=
D1+ D2+ D3+……...D5
(1+i)5
(1+i) (1+i)2 (1+i)3
or
P◦= D1+P1
(1+r)1
FORMULAS TO BE USED IN
NUMERICAL
• Dividend discount models
= D1+ D2+ D3+……………….+D◦(1+g)∞
(1+Ke)∞
(1+i) (1+i)2(1+i)3
• Assumptions
1) When dividend increase at zero rate…..Growth rate is
zero
D = D₁
I
Ke
2)
When dividend increase with a constant rate the
formula used to calculate the intrinsic value of
common stock is:
V= D₁/(ke-g)
QUESTION NO.1
• Wayne’s Steak ,Inc. has a 9 %,noncallable,$100 par value preferred stock
issue outstanding. On January 1 the market
price per share is $73 .Dividends are paid
annually on Dec 31. If you require a 12%
annual return on this investment, what is
this stock intrinsic value to you on Jan,1?
QUESTION NO.2
• Delphi products corporation currently pays
a dividend of $2 per share, and this
dividend is expected to grow at a 15%
annual rate of three years, and then at a 10
% rate of the next 3 years, after which is
expected to grow at 5% rate forever. What
value you would place on the stock if an 18
% rate of return required?
QUESTION NO.3
• XYZ company currently paid a dividend of
Rs.5.5 per share. This dividend is expected
to grow at 15% for the first 4 years ,13%
for next 3 years,7% forever. The rate of
return currently prevailing in the market is
10% .Calculate the value of common stock.