WEEK 6 - Valuation of Shares Flashcards
What are the elements of Ordinary Shares?
- Represent equity share capital of the firm
- Part Owners of the firm
- Vote at shareholder meetings
- Right to receive share of dividends distributed
- Each shareholder entitled to copy of the annual report
- No agreement between ordinary shareholder and company that the investor will receive back the original capital invested
What are the elements of holding debt? (i.e Company owes you)
- Usually the lenders to the firm have no official control
- Usually requires regular cash outlays in the form of interest and the repayment of the capital sum (firm will be obliged to maintain the repayment schedule through good years and bad)
What are the disadvantages of Ordinary Shares for investors?
- Last in the queue to have their claims met
What is the importance of a well run stock exchange?
- Firms can find funds and grow
- Allocation of capital
- Status and publicity
- Mergers
- Improves corporate behaviour
How do we get the Dividend Valuation Model if we assume Dividends are constant? (Model to infinity)?
Simply via transforming the expected holding period return
Secondly, by finding each period’s answer
(SEE IN NOTES)
What is the Dividend Valuation Model if we assume Dividends are constant? (Model to infinity)
P0 = D1 +P1 / (1+R) = D1/1+R + P1/1+R
SEE IN NOTES
What is the calculation to the first Dividend Growth Model?
d1 = (1+g)d0
- Assuming dividends grow at a constant rate of G
(SEE IN NOTES)
How do you find the second dividend growth model?
By finding the sum of the geometric series of the first model
(SEE IN NOTES)
What is the second dividend growth model?
P0 = d0(1+g)/r-g = d1/r-g
Where: p0 = Current Price d1 = Future Dividend r = Required rate of return g = Growth rate of dividend
USE THIS ONE
EXAMPLES OF SECOND DIVIDEND GROWTH MODEL
SEE PRACTISE Q IN NOTES
AND SEE PEARSON PLC IN NOTES
What is the required rate of return based on the second dividend growth model?
r = d1/po +g
How do we calculate Non-constant growth?
Step 1: Calculate dividends for super normal growth phase
Step 2: Calculate Share Price at time 3 when the dividend growth rate shifts to new permanent rate
Step 3: Discount and Sum the amount calculated in Stages 1 and 2
EXAMPLE OF NORUCE PLC IN NOTES
What are the issues with the Divdend Growth Model?
- Companies that do not pay dividends
There are problems with the dividend valuation models i.e.
- Highly sensitive to the assumptions
- The quality of input data often poor
- If G exceeds R a nonsensical result occurs
How can we forecast the dividend growth rates (g)?
Determinants of Growth:
- The quality of resources retained and reinvested within the business
- Rate of return on existing assets
- Rate of Return earned on existing assets
- Additional Finance
Growth - Focus on the firm:
- Strategic analysis
- Evaluation of Managment
- Using historic growth rate of dividends
- Financial statement evaluation and ratio analysis
- Growth - Focus on economy
What are the downsides to using a comparison measure like the PER Model?
- Some analysts use PER (P0/E0) to make comparisons between firms
- Analysing through comparisons lacks intellectual rigour
(As it boldly assumes the ‘comparable’ companies are correctly priced) - Fails to provide a framework for the analyst to test the important implicit input assumptions
SEE EXAMPLE OF RIDGE PLC IN NOTES
