FINA312 A- 03 05 2018 - Lecture notes 3 PDF

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This lecturer was Dr Peter Huang...

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PORTFOLIOS & MARKETS – CHAPTER EIGHTEEN

Announcements • • • •

Use other platforms like NZX virtual trading Answers are upload for the first assignment If you have any problem with the marks can talk to the lecturer Marks might be reduced because of not having followed the instructions or insufficient details and examples

Equity valuation models This lecturer explains the main three models of equity valuation. Namely, 1. Dividend discount model 2. Present value of growth opportunities 3. Comparable (Ratios)

1. DIVIDEND DISCOUNT MODEL (DDM) • • •

The dividend discount model (DDM) is a procedure for valuing a stock's price by discounting predicted dividends to the present value This is the simplest model for evaluating the equity Characteristics in formula ¨ D – Expected dividend payment ¨ K – This is the discount rate, and this also can be named as required rate of return & market capitalization rate, but idea is similar. This is the risk of the equity Dividend payments are not predictable Formula will be provided for the examination t

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Constant growth DDM • •

It is assumed that dividends growing at a rate that can be sustained forever. It is important to remember that, V is the value in the current period & D is the dividend in the next period. If not, you can use D with the growth rate to calculate V i.e. D (1+g) = D Tencent holdings Ltd can be identified as an example for constant growth model. o

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DDM Implications • •

The lower the market capitalization rate (Why) – Because less risky, price of the stock will be larger and actual return is high when compared with other firms The stock price is expected to grow at the same rate as dividends (Why) – There are lots of potentials

Price over time •

Constant dividend model ¨ Coca-Cola & Microsoft pay very stable dividends over the period of time ¨ Stock price is similar to the previous price ¨ Only dividend can generate returns

Dividend payment

Stock price increase •

Constant growth model ¨ After the dividend payment stock prices are higher than the previous prices ¨ Companies’ profit will be invested for the growth ¨ Can have capital gains

Dividend payment

Stock price increase

Estimating growth rate • •

ROE is used to identify the return that can generate from an investment b is the retention percentage from the profit

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From the financial statements also, we can find these information

Honda example •

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2012

As per this example information for 2017 has not been given but information for 2016 has been given with the growth rate. Therefore, value of the 2016 is equal to the dividend value of 2016 with the growth rate (Slide no 12) Expected dividends should be discounted to year 2012 There are cash flows even after 2016, first all the cash flows need to be discounted to 2016 and then 2012 Final examination question will be similar to this example

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2016

2. Present value of growth opportunities • •

Different angel to look at the prices of the stocks Firm is making profits but no expansion because all earnings are paid as dividend

Example • • • •

First calculate the current price (P ) Year-end dividend means next year dividend The PVGO amount (-11.11) is negative. It means no growth opportunities and damaging the value of the shareholders If company can change the payout policy, amount could be positive and it’s also good for the shareholders o

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3. Comparable (Ratios)

Many firms don’t pay the dividends, especially the new firms If we want to compare two companies, those companies should be in the same industry • In the example Microsoft’s financial highlights have been compared with the industry average. As per the example price earnings ratio is lower in Microsoft when compared with industry average. Low prices in Microsoft when compared with industry might be the reason for it. • •

Limitations of comparable If the historical information is not available and if the dividends are not stable, this method can be used. But there are few limitations also. • • •

Different companies might have used different standards therefore information has to be converted into similar standards Sometimes true information might not reflect in the financial statements and other documents Companies should be in the same industry. In the same industry also have to consider about the size of the company, growth opportunities etc.

Questions •

Why NZ equity market is so strong – NZ equity market is less affected by the financial crisis

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