Equity Valuation Flashcards
(22 cards)
. What is a capital market?
A capital market is a market in which long-term funds are raised and long-term debt and equity securities are traded.
What is the difference between the primary and secondary markets?
Primary Market: Where new securities are issued (e.g., IPO, SEO).
Secondary Market: Where existing securities are traded among investors.
What are the key functions of Investment Banks (IB) in the capital market?
Asset Management
Corporate Finance (e.g., IPOs, SEOs)
Trading Services
What is an Initial Public Offering (IPO)?
The first public sale of a company’s shares to outside investors.
. What is a Seasoned Equity Offering (SEO)?
An equity issue by a company that already has ordinary shares outstanding.
What are ordinary shares (common stock)?
Represent ownership in a company.
Residual claimants (paid after debts, preferred shares).
High risk, high potential return.
Voting rights on directors and major events.
What are preference shares?
Priority over ordinary shares in dividends & liquidation.
Usually no voting rights.
Cumulative: Unpaid dividends accumulate.
Non-cumulative: Missed dividends do not accumulate.
What are the main techniques for share valuation?
Dividend Discount Model (DDM)
Corporate Valuation Model
Multiples of Comparable Firms
What are the types of Dividend Discount Models (DDMs)?
Constant Dividend Model
Constant Growth Model (Gordon Growth)
Non-Constant Growth Model
What is the DDM formula for a one-year investor?
Po= (Div + P1)/(1+rE)
How is total return on a stock calculated?
rE = (Div1/Po)+((P1-Po)/Po) (DividendYield+CapitalGain)
What is the Constant Dividend Growth Model formula?
Po=Div1/(rE-g)
Div1= divident next period
rE=equity cost of capital
g=dividend growth rate
When is the Constant Growth Model inappropriate?
When dividend growth is not stable or constant (e.g., young or high-growth firms).
How is value estimated for changing growth rates?
Forecast dividends during the high-growth period.
Use the Constant Growth Model to value the stock at the start of stable growth.
Discount all cash flows to present.
What is the formula to value a preference share with fixed dividends?
P0=Div1/rps
Where rps= required return for preference shares.
What are the limitations of the Dividend Discount Model (DDM)?
Uncertainty in future dividend estimates.
Sensitive to small changes in growth rate assumptions.
What is the Efficient Markets Hypothesis (EMH)?
Securities are fairly priced based on all available information.
What are the three forms of EMH?
Weak Form: Prices reflect past market data.
Semi-Strong Form: Prices reflect all public information.
Strong Form: Prices reflect all information, public and private.
How does competition ensure efficient pricing in markets?
Information is quickly absorbed into stock prices as investors act on new data, preventing mispricing.
What does the Valuation Triad represent?
The relationship between a firm’s future cash flows, cost of capital, and its stock price.
How to solve for implied dividend growth rate if price is known?
Rearrange Constant Growth DDM:
g= rE-(Div1/Po)
What is the market implication if actual price > DDM price estimate?
The market expects higher dividend growth than assumed in the DDM.
