VALUATION by Reynaldo Nograles (2)

7/28/2019 VALUATION by Reynaldo Nograles (2)

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Q: Given the market price MPo of a common

stock in the market, how would an investor

know if this stock is worth buying or not?

A: The investor determines the INTRINSIC VALUE Po ofthis common stock and then compares this intrinsicvalue with the market price MPo. If Po>MPo => the stock is worth buying. If Po the stock is NOT worth buying(or the investor sells the stock ifhe/she already has it) If Po=MPo => the investor needs some othercriterion or basis for buying ornot buying the stock.

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WINTERTemplate

3STOCK VALUATION METHODS OR METHODS OF

DETERMINING THE INTRINSIC VALUE OF THE

COMMON STOCK OF A COMPANY:

PSEion thereturnofrateexpectedthe)E(R

stockcommonon therisksystematicthe

returnofratefree-riskthe

-)(

companytheROEoftheor

investortheofreturnofratedesiredthe

yeartheofendat thestocktheofpriceestimatedP

yeartheofendat thepaidbetoshareperdividendestimatedD:where

1

periodholdingyear1:1METHOD

M

1

1

110

f

fMf

R

RR

ERor

k

k

PDP


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STOCK VALUATION METHOD

(cont inuat ion) 4

H

H

H

H

k1

P

k1

D

k1

D

k1

D

k1

DP

)()(...

)()(

d)whiteboaron the

diagramtimethe(showyearsHPeriodHolding:2METHOD

3

3

2

210

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5

A plans to buy ABC Corp. common stocks now. Heprojects that ABC would pay annual dividends ofP5, P6 and P8 per share at the end of years 1, 2 and3, respectively, and that the price of the stock at the

end of year 3 would be P100 per share. A expectsthe rate of return on the PSEi to be 15% per year andthe risk free rate to be 6% p.a. The systematic riskon the stock is 1.5. If the stocks current market priceis P71 per share,

a) Calculate the intrinsic value of the stock.

b) Is the stock worth buying now? EXPLAIN.

ANSWER: a.) P0 = P71.674

WORKSHOP PROBLEM: (to be solved by

group after the presentation):

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6STOCK VALUATION METHOD

(cont inuat ion)

stocks.commongfor valuin

DDMor theMODELDISCOUNTDIVIDENDtheisThis

)(...

)()(

:asdownwrittenbecan

2METHODunderPforequationthebig,infinitelyHIf

big)infinitelyH(i.e.,PeriodHoldingIndefinite:3METHOD

3

3

2

210

0

k1

D

k1

D

k1

D

k1

DP

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N.B.: The DDM asserts that1. The intrinsic value P0 of a common stock

is equal to the PV of all expected future

dividends into PERPETUITY.

2. The intrinsic value P0 of a common stockis determined ultimately by the

DIVIDENDS that the stock would pay inthe future.


(cont inuat ion)


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(cont inuat ion)

+=......;+=

;+=+=;+=

yeartoyearfromconstant=

dividendstheofrategrowthannualthe=g

yearPREVIOUStheof

endtheatdividendtheordividendcurrentthe=

ModelSHAPIRO-GORDONtheorDDMGrowthconstantthe:4METHOD

3

3

2121

0

H

0H0

00

g)(1DDg)(1DD

g)(1Dg)(1DDg)(1DD

Dlet

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(cont inuat ion)

)2.4(

)(...

)(

:g1

k1by4.1EquationMultiply

)(...

)()(

:aswrittenbecanequationDDMThen the

1

1

2

2

00

3

3

2

2

0

Equation

k1g)(1D

k1g)(1D

k1g)(1DDP

g1k1

4.1)(Equation

k1

g)(1D

k1

g)(1D

k1

g)(1D

k1

g)(1DP

H

H

000

H

H

0000

9


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(cont inuat ion)

)1(

11

11

0)1(

)1(HwhenANDwhen

:4.2Equationfrom4.1EquationSubtract

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00

000

gk

DPor

gk

gDPor

DPggkorDP

gk

k

g,gk

k)(1

g)(11DP1

g1

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ork)(1

g)(1DDPP

g1

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o

H

H

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00

H

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0

000

10


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(cont inuat ion)

WORKSHOP PROBLEM FOR METHOD 4( to be solved by groupafter the presentation):Last year, ABC Corporation paid out dividends of P6 pershare and it is assumed that these dividends will grow annually at a

constant rate of 10%. It is expected that the rate of return on the PSEiwill be 20% p.a. and that the risk-free rate will be 5% p.a. If thesystematic risk on ABCs common stock is 1.2 and if its current marketprice is P54 per share,a.) determine the intrinsic value of the stock.b.) Is ABCs common stock worth buying? EXPLAIN.

ANSWER: P0 = P50.7711


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(cont inuat ion)

sharescommonoustandingNo.of

sliabilitieassetsofvaluerealizableNetshareperNAV

MethodNAVThe:5METHOD

N.B.:1. This method is commonly used to value the common stocks of

real estate development companies like ALI, Megaworld, FLI,

etc.

2. The method is most suitable for valuing the common stocks of acompany that is under LIQUIDATION.


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(cont inuat ion)

00 EPSxPERAVERAGEP

Method(PER)RatioingsPrice/EarnThe:6METHOD

where:PER = price/earnings ratio = market price as of the end of agiven year EPS or earnings per share at the end of that

year

EPS at the end of any given year= net income after tax duringthe given year No. of outstanding common shares as of endof that year

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14where:AVERAGE PER = the average PER of the company

during the LAST SEVERAL YEARS or the PER ofthe SECTOR or INDUSTRY to which the company

belongs

EPS0= the current earnings per share of thecompany or the earnings per share at the end of

the PREVIOUS YEARN.B.: Pause for 15 seconds to allow Method 6 to sink in!


(cont inuat ion)

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(cont inuat ion)

Notes on the PER:1. The PER of a common stock may be interpreted as the numberof pesos that the investor would be willing to pay for everypeso of net income that the common stock earns.

2. The PER of a common stock is NOT CONSTANT; it changes

from year to year

3. The FORWARD PER of a common stock (i.e., the stocks PER oneyear from now) may be obtained by dividing the stocks currentintrinsic value by the estimated EPS at the end of that one year;that is,

1

0

EPS

PPERFORWARD

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(cont inuat ion)

4.) Under the GORDON-SHAPIRO Model, the FORWARD PERis given by

)3.4(g-k

b-1

g-k

-1

g-kg-k

g-k

/1

g-k

1

1

1

11

1

1

10

1

0

EquationPERFORWARDor

YEARFORWARDTHEOFENDTHEATRATEPLOWBACKEXPECTED

EDPRYEARFORWARDTHEOFENDTHEATRATIOPAYOUTDIVIDENDEXPECTED

EPSD

EPS

D

EPSP

EPS

PPERFORWARD

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(cont inuat ion)

5.) After obtaining the value of the FORWARD PERfrom Equation 4.3, this value may be used toESTIMATE the price P1 of the common stock atthe end of the forward year; that is,

gEPSgkb

xEPSgk

b

EPSxPERFORWARDP

11

1

01

11

11


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(cont inuat ion)

WORKSHOP PROBLEM FOR METHOD 6( to be solved by groupafter the presentation):ABC Corporation pays annual common stock dividendsthat grow or increase at a constant rate of 10% per year. Duringthe current year, ABC paid dividends of P8 per common share. Bythe end of year 1, it is estimated that ABC will earn P70 percommon share, 85% of which would be retained by the company.It is expected during year 1 that the rate of return on the PSEi wouldbe 15% and that the risk-free rate would be 6% p.a. It is alsoknown that the systematic risk on the stock is 1.5.a) Determine the intrinsic value of the stockb) If the current market price of the stock is P95 per share,is the stock worth buying now or not?c) Estimate the price of the stock at the end of year 1.ANSWERS: P0 = P92.632; P1 =P110.526

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(cont inuat ion)

EBITDA

EVorValueEnterpriseEMMULTIPLEENTERPRISE

Method(EM)MULTIPLEENTERPRISEThe:7METHOD

where:EV = Market Capitalization + LT debts Cash equivalents Marketable or Tradeable Securities or Investments

Market Capitalization = current market price of the common stock xNo. of outstanding common shares

EBITDA = Earnings before INTEREST, TAXES, DEPRECIATION andAMORTIZATION

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(cont inuat ion)

NOTES ON METHOD 7 (EM Method):1) The method takes into account the LT debts of the company

2) The method is more appropriate for comparing companieshaving operations in different countries because it does not

consider the distorting effects of international taxation policiesand depreciation practices

3) The method can be used even for companies that incur andreport net losses

4) A LOW EM compared to other companies in the same industryindicates that the company is UNDERVALUED which can be abasis for BUYING THE company.

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(cont inuat ion)

INTERMISSION (before going to METHO D 8):DETERMINING THE WEIGHTED AVERAGE COST OF CAPITAL orWACC OF A COMPANYSTEP 1: Obtain the cost KPS of preferred stocks, the cost KCS ofcommon stocks and the cost KLTD of LT debts.

STEP 2: Calculate the WACC using as weights the proportions ofpreferred stocks, common stocks and LT debts to the TOTAL CAPITALof the company;i.e., WACC = WPSKPS + WCSKCS + WLTDKLTD (1-CITR)N.B.:1. WPS, WCS AND WLTD should be in decimals and their sum should

be equal to 1; i.e., WPS + WCS+ WLTD = 12. The values of KPS, KCS, KLTD may be left in PERCENTAGES.3. CITR = the corporate income tax rate of the company

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DETERMINING THE COST OF

PREFERRED STOCK (KPS)

WHERE:DPS = the annual AMOUNT of dividend PER

SHARE on the preferred stock

NPS = the NET PROCEEDS PER SHARE fromthe sale of the preferred stock= selling price per share of the preferredstock underwriting or flotation expenseper share

PS

PS

PSN

DK


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23DETERMINING THE COST OF

COMMON STOCK (KCS)

gMP

DKk

gP

Dk

kforSolving

D

RRERk

CS

fMf

0

1

00

0

1

10

CS

:stocktheof)(MPpricemarketcurrentthebyPREPLACING

:

g-kP

:equationSHAPIRO-GORDONtheUsing:BMethod.)2

-)(K

:CAPMtheUsing:AMethod.)1

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(cont inuat ion)

3

3

2

2T

T

)(

....

)()(V

is,thatrate;discounttheas

WACCscompany'theusingsOFCF'or

FLOWSCASHFREEOPERATINGANNUALthegdiscountin

byenterpriseorcompanyENTIRE

theofVuemarket valObtain the:1STEP8.1)

:STEPS

:Method(DOFCF)FLOWCASH

FREEOPERATINGDISCOUNTEDThe:8METHOD

WACC1

OFCF

WACC1

OFCF

WACC1

OFCF

WACC1

OFCF1

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(cont inuat ion)

WHERE:OFCFt = the EXPECTED operating free cash flowat the end of the year t

= the amount of cash flow available to

investors (i.e., the shareholders and theproviders of LT debts or creditors) afterthe company has set aside allamounts or monies needed for

operation and to pay for thecompanys investments in fixed assetsand current assets.

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26METHOD 8: THE DISCOUNTED OPERATINGFREE CASH FLOW METHOD (CONTINUATION)In practice, VT is obtained by using an equation

which is homologous to the GORDON-SHAPIROMODEL equation for obtaining the intrinsic value Po. Thisequation for VT is

Where:OFCFo = the opeating free cash flow at the end

of the current year.g = the constant annual growth rate of the

OFCFs

gWACC

gOFCFV OT

)1(

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27METHOD 8: The DISCOUNTEDOPERATING FREE CASH FLOWMethod (continuation)8.2) STEP 2: Determine the market value VLTD of

all the companys LT debts.

8.3) STEP 3: Determine the market value VPS ofthe companys preferred stocks

8.4) STEP 4: Obtain the market value VCS of thecompanys common stocks;i.e., VCS = VT VLTD VPS

8.5) STEP 5: Determine the intrinsic value P0 of thecompanys common stocks;i.e.,

sharescommongoutstandinofNo.

V=P

CS

o

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(cont inuat ion)

WORKSHOP EXERCISE FOR METHOD 8:The end-of-year operating free cash flow for theCURRENT YEAR of ABC Corporation is 600,000Php

and this cash flow is projected to GROW AT ACONSTANT RATE of 3% p.a. The market value of all thecompanys LT debts is 3.1MPhp while the market valueof its preferred stocks is 800,000Php. The companysWACC is 9% p.a. If the company issued 1M outstandingcommon shares, find the intrinsic value per share ofthese common stocks. (Answer: 6.40Php)

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VALUATION by Reynaldo Nograles (2)

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