Stock Valuation

Adam Yoder
Misa Ngo
 Valuation methods
Discounted Cash Flow: Dividends
Present Value of Growth Opportunities
P/E ratio: Price/ Earnings
PEG ratio: PE/ Growth
 Discounted Cash Flow Model
Formulas: Div 1
P0
rg

g ROE * plowback _ ratio

r CAPM rf b(rm rf )
 DCF example
Corp A:
Earnings/shr.=$1
Book equity/shr.=$10
Dividend/shr.=$0.50
ROE= EPS/ book =10%
Plowback ratio= RES / EPS= .5

g= ROE * Plowback ratio = 0.1 * 0.5 = 5%

r= rf + b(rm-rf) = 0.05 + 0.75(0.1 - 0.05) = 8.75%

.5
P0 $13.33 / shr .
.0875 .05
 DCF Practice Question
Corp. B:
Earnings/shr.=$3
Book equity/shr.=$15
ROE is 3/15 = 20%
Dividend/shr.=$1.75
Risk free rate = 5%
Beta on this stock is 1.25
S&P market return is 10%

g= ROE * Plowback ratio = 0.2 * .416 = 8.3%

r= rf + b(rm-rf) = 0.05 + 01.25(0.1 - 0.05) = 11.25%
1.75
Po $59.32
.1125 .083
 Present Value of Growth
Opportunities (PVGO)
- Net present value of a firms future
investments

EPS1
Po PVGO
r
EPS1/r: No-growth capitalized value per share
(EPS1=DIV1, P0=DIV1/r)
 Present Value of Growth
Opportunities (PVGO)
Example
ROE = .2
Payout ratio = .6, Plowback ratio = .4
EPS1 = $5.00, DIV1 = $3.00, r = 15%

Find PVGO?
P0 = DIV1/(r-g)
P0 = EPS1/r + PVGO
 Present Value of Growth
Opportunities (PVGO)
Example

g = ROE x Plowback ratio = .2 x.4 = .8 (8%)

P0 = DIV1/(r-g) = 3/(.15-.08) = $42.86
No-growth value = EPS1/r = 5/.15 = 33.33
PVGO = P0 EPS1/r = $42.86-$33.33 =
$9.52
 Price/Earnings Ratio (P/E)
Amount investors are willing to pay for each dollar of
earnings
Higher P/E may indicate high growth potential of the
firm
Current stock price/annual EPS
Po d

EPS1 rg
d: payout percentage (constant)
EPS1: next year EPS
r: required rate of return
g: dividend growth rate
 Price/Earnings Ratio (P/E)
Price of a stock paying dividend D1 at a constant growth
rate g
Div 1
P0
r g
Assume the firm pays out a constant percentage d of its
earnings E1

dEPS1
Po
(r g )
Divide both sides by E1

Po d

EPS rg
 Price/Earnings Ratio (P/E)
Example
ROE= .16
d = .7
r= 16%

Find P/E ratio?

P0/EPS1=d/(r-g)
 Price/Earnings Ratio
Example
g= ROEx Plowback Ratio = ROEx(1-d)
= .16x(1-.7) = .048

P0/EPS1= d/(r-g) = .7/(.16-.048) = 6.25

 PEG Ratio
Used by many analysts to determine a valuation
when a stock has little or no dividend and high
growth prospects.
Formulas: PEG = PE / G
P0 = g * PEG * EPS
Traditional thought is a PEG = 1 is fairly valued
Company A:
$2 EPS
Estimated growth of 15% for next 5 yrs.
Fair value is $30 per share.
 PEG Ratio
Recently the PEG ratios have increased
significantly due to lower discounting rates
in the T-bills.
The current S&P PEG ratio is around 1.5
$2 EPS
Estimated growth of 15% for next 5 yrs.
Fair value is $45 per share.
 PEG Practice Question
Company B:
$3 EPS
20% growth over next 5 years
1.4 Industry average PEG

Formula: P = g * PEG * EPS

0

P = 20 * 1.4 * 3 = $84
0
Questions?