Case 3
Valuation - Corporate Bonds, Preferred Stock, Common Stock
Valuation of Corporate Bonds - Valuing a contract
Valuation of Common Stock - Based on assumptions - valuing expectations
Valuation of Preferred Stock - Valuing cash flows (do not assume it is callable)
Corporate Bond Quotes
(source: FINRA Investor Information; http://cxa.marketwatch.com/finra/BondCenter/Default.aspx)
Bond
Symbol
Issuer Name
Coupon
Maturity
Callable
Moody’s
S&P
Price
Yield
F.GX
Ford Motor Co
6.375
2/1/29
No
Ca
CCC
20.540
31.28
GE.HGU
GE Capital Cor
6.750
12/15/16
No
Aaa
AAA
102.500
6.35
GE.GGM
GE Capital Cor
4.750
6/15/17
Yes
Aaa
AAA
90.500
6.21
Bond Ratings – Investment Quality
High Grade
#
Moody’s Aaa and S&P AAA – capacity to pay is extremely strong
#
Moody’s Aa and S&P AA – capacity to pay is very strong
Medium Grade
#
Moody’s A and S&P A – capacity to pay is strong, but more susceptible to changes in
circumstances
#
Moody’s Baa and S&P BBB – capacity to pay is adequate, adverse conditions will have
more impact on the firm’s ability to pay
Bond Ratings – Speculative (Junk)
Low Grade
#
Moody’s Ba, B, Caa and Ca
#
S&P BB, B, CCC, CC
#
Considered speculative with respect to capacity to pay. The “B” ratings are the lowest
degree of speculation.
Very Low Grade
#
Moody’s C and S&P C – income bonds with no interest being paid
#
Moody’s D and S&P D – in default with principal and interest in arrears
Bond Evaluation
Use bond rating - yield comparisons
Also, consider maturity, liquidity, call provision, convertibility feature, collateral, other
provisions
Credit Rating Companies - Moody’s, Standard and Poors, Fitch
Websites:
http://cxa.marketwatch.com/finra/BondCenter/Default.aspx
http://www.investinginbonds.com/
http://www.bondsonline.com/
Valuing Stocks
Common Stock - Provides ownership in a corporations and a resulting residual claim.
Features of Common Stock:
(1)
(2)
(3)
(4)
Residual claim on income
Residual claim on assets
Voting rights
No maturity
Models:
(1) Zero Growth Model
P0 = D / rs
(2)
Constant Growth Model
P0 = D1
rs-g
(3) Variable Growth Model
P0 = j [ Dt / (1+rs)t
g = growth rate = RR * ROE
RR = retention ratio
ROE = Return on Equity
Stock price movement:
P0 = D1
rs-g
why ªP0
if ªD1 - - based on earnings, payout ratio
if ªrs - - based on company risk, inflation
rs = real rate + E(inflation) + risk premiums
if ªg - - based on earnings, future prospects
Stock Evaluation
Technical Analysis:
Capturing investor sentiment
Trends in stock prices (50-day and 100-day moving average)
Trends in volume
Over-reaction and under-reaction
Candlesticks, Head-and-Shoulders, Double Tops and Bottoms, Relative Strength Index (RSI),
Bollinger Bands, Moving Average Convergence Divergence (MACD), Stochastics
Fundamental Analysis:
Top-down - Start with looking at the “Big Picture”.
Economy - Broad Sectors - Industry - Company
Look at interest rates, economic cycles, economic trends, etc.
Bottom-up - Selecting a stock based on the individual attributes of a company.
Find strong companies with good prospects
Look at PE Ratios, PEG Ratios, cash flow, cash position, debt, new products or contracts, etc.
Web Sources:
http://www.dividenddiscountmodel.com/
http://www.nasdaq.com/
http://www.nyse.com/
http://finance.yahoo.com/
Preferred Stock - A hybrid security that has some features similar to common stock and some
similar to corporate bonds.
Stock-like Provisions: (1) no maturity, (2) If Dividends payments are missed may give Voting
Rights.
note: If Dividends payments are missed often a cumulative feature,
Bond-like Provisions: (1) Offers a priority claim on assets to common stock, (2) Conversion, (3)
Callable, (4) Sinking Fund.
Valuing:
Vp = Dp / rp
where Dp
= annual dividend
rp
= required rate of return on PS