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 
rg
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 firm’s 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
rg
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
P0
Div 1

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
rg
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
 P = 20 * 1.4 * 3 = $84
0
0
Questions?