Thị trường tài chính và các định chế tài chính_ Chapter 11

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Chapter 11
Stock Valuation and Risk
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Stock valuation methods

Determining the required rate of return to value stocks

Factors that affect stock prices

Role of analysts in valuing stocks

Stock risk

Applying value at risk

Forecasting stock price volatility and beta

Stock performance measurement

Stock market efficiency

Foreign stock valuation, performance, and efficiency
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Stock Valuation Methods


The price-earnings (PE) method assigns the
mean PE ratio based on expected earnings of
all traded competitors to the firm’s expected
earnings for the next year

Assumes future earnings are an important
determinant of a firm’s value

Assumes that the growth in earnings in future years
will be similar to that of the industry
4
Stock Valuation Methods (cont’d)

Price-earnings (PE) method (cont’d)

Reasons for different valuations

Investors may use different forecasts for the firm’s earnings
or the mean industry earnings

Investors disagree on the proper measure of earnings

Limitations of the PE method

May result in inaccurate valuation for a firm if errors are
made in forecasting future earnings or in choosing the
industry composite

Some question whether an investor should trust a PE ratio
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Valuing A Stock Using the PE
Method
A firm is expected to generate earnings of $2 per
share next year. The mean ratio of share price
to expected earnings of competitors in the
same industry is 14. What is the valuation of
the firm’s shares according to the PE method?
$2814$2
ratio) PEindustry (Meanshare) per firm of earnings Expected(share per Valuation
=×=
×=
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Stock Valuation Methods (cont’d)

Dividend discount model

John Williams (1931) stated that the price of a stock
should reflect the present value of the stock’s future
dividends:

D can be revised in response to uncertainty about the firm’s
cash flows

k can be revised in response to changes in the required rate
of return by investors
∑
∞
=
+
=

1
)1(
Price
t
t
t
k
D
k
7
Stock Valuation Methods (cont’d)

Dividend discount model (cont’d)

For a constant dividend, the cash flow is a
perpetuity:

For a constantly growing dividend, the cash flow is
a growing perpetuity:
k
D
k
D
t
t
t
=
+
=
∑

∞
=1
)1(
Price
gk
D
k
D
t
t
t
−
=
+
=
∑
∞
=
1
1
)1(
Price
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Valuing A Stock Using the
Dividend Discount Model
Example 1: A firm is expected to pay a dividend
of $2.10 per share every year in the
foreseeable future. Investors require a return
of 15% on the firm’s stock. According to the
dividend discount model, what is a fair price

for the firm’s stock?
14$
%15
10.2$
)1(
Price
1
===
+
=
∑
∞
=
k
D
k
D
t
t
t
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Valuing A Stock Using the
Dividend Discount Model
Example 2: A firm is expected to pay a dividend
of $2.10 per share in one year. In every
subsequent year, the dividend is expected to
grow by 3 percent annually. Investors
require a return of 15% on the firm’s stock.
According to the dividend discount model,
what is a fair price for the firm’s stock?

50.17$
%3%15
10.2$
)1(
Price
1
1
=
−
=
−
=
+
=
∑
∞
=
gk
D
k
D
t
t
t
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Stock Valuation Methods (cont’d)

Dividend discount model (cont’d)

Relationship between dividend discount model

and PE ratio

The PE multiple is influenced by the required rate of
return and the expected growth rate of competitors

The inverse relationship between required rate of return
and value exists in both models

The positive relationship between a firm’s growth rate
and its value exists in both models
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Stock Valuation Methods (cont’d)

Dividend discount model (cont’d)

Limitations of the dividend discount model

Errors can be made in determining the:

Dividend to be paid

Growth rate

Required rate of return

Errors are more pronounced for firms that retain most of
their earnings
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Stock Valuation Methods (cont’d)


Adjusting the dividend discount model

The value of the stock is:

The PV of the future dividends over the investment
horizon

The PV of the forecasted price at which the stock will be
sold

Must estimate the firm’s EPS in the year they plan to sell
the stock by applying an annual growth rate to the
prevailing EPS
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Using the Adjusted Dividend
Discount Model
Parker Corp. currently has earnings of $10 per
share. Investors expect that the EPS will
growth by 3 percent per year and expect to
sell the stock in four years. What is the EPS
in four years?
26.11$)03.1(10$
)1( yearsn in earnings Forecasted
4
=×=
+=
n
GE
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Using the Adjusted Dividend

Discount Model (cont’d)
Other firms in Parker’s industry have a mean PE
ratio of 7. What is the estimated stock price in
four years?
82.78$726.11$
industry) of ratio (PE years)4 in Earnings( years4 in price Stock
=×=
×=
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Using the Adjusted Dividend
Discount Model (cont’d)
Parker is expected to pay a dividend of $2 per
share over the next four years. Investors
require a return of 13% on their investment.
Based on this information, what is a fair value
of the stock according to the adjusted
dividend discount model?
29.54$
)13.1(
82.78$
)13.1(
2$
)13.1(
2$
)13.1(
2$
)13.1(
2$
44321
=

++++=PV
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Stock Valuation Methods (cont’d)

Adjusting the dividend discount model
(cont’d)

Limitations of the adjusted dividend discount
model

Errors can be made in deriving the PV of dividends over
the investment horizon or the forecasted price at which
the stock can be sold

Errors can be made if an improper required rate of return
is used
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Determining the Required Rate of
Return to Value Stocks

The capital asset pricing model:

Assumes that the only important risk is systematic
risk

Is not concerned with unsystematic risk

Suggests that the return on an asset is influenced by
the prevailing risk-free rate, the market return, and
the covariance between a stock’s return and the

market’s return:
)(
fmjfj
RRBRR −+=
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Determining the Required Rate of
Return to Value Stocks (cont’d)

The capital asset pricing model (cont’d)

Estimating the risk-free rate and the market risk premium

The yield on newly issued T-bonds is commonly used as a proxy
for the risk-free rate

The terms within the parentheses measure the market risk
premium

Historical data over 30 or more years can be used to determine
the average market risk premium over time

Estimating the firm’s beta

Beta reflects the sensitivity of the stock’s return to the market’s
overall return

Beta is typically measured with monthly or quarterly data over the
last four years or so
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Using the CAPM

Fantasia Corp. has a beta of 1.7. The prevailing
risk-free rate is 5% and the market risk
premium is 5%. What is the required rate of
return of Fantasia Corp. according to the
CAPM?
%5.13
%)5%10(7.1%5
)(
=
−+=
−+=
fmjfj
RRBRR
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Determining the Required Rate of
Return to Value Stocks (cont’d)

The capital asset pricing model (cont’d)

Limitations of the CAPM

A study by Fama and French found that beta is unrelated to
the return on stock over the 1963–1990 period

Chan and Lakonishok:

Found that the relation between stock returns and beta
varied with the time period used

Concluded that it is appropriate to question whether beta is

the driving force behind stock returns

Found that firms with the highest betas performed much
worse than firms with low betas

Found that high-beta firms outperformed low-beta firms
during market upswings
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Determining the Required Rate of
Return to Value Stocks (cont’d)

Arbitrage pricing model

Suggests that a stock’s price can be influenced by a
set of factors in addition to the market

e.g., economic growth, inflation

In equilibrium, expected returns on assets are linearly
related to the covariance between assets returns and
the factors:
∑
=
+=
m
i
ii
FBBRE
1
0

)(
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Factors That Affect Stock Prices

Economic factors

Impact of economic growth

An increase in economic growth increases expected cash
flows and value

Indicators such as employment, GDP, retail sales, and
personal income are monitored by market participants

Impact of interest rates

Given a choice of risk-free Treasury securities or stocks,
stocks should only be purchased if they offer a sufficiently
high expected return
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Factors That Affect Stock Prices
(cont’d)

Economic factors (cont’d)

Impact of the dollar’s exchange rate value

The value of the dollar affects U.S. stocks because:

Foreign investors purchase U.S. stocks when the dollar is

weak

Stock prices are affected by the impact of the dollar’s
changing value on cash flows

Some U.S. firms are involved in exporting

U.S.-based MNCs have some earnings in foreign currencies

Exchange rates may affect expectations of other economic
factors
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Factors That Affect Stock Prices
(cont’d)

Market-related factors

Investor sentiment

In some periods, stock market performance is not highly
correlated with existing economic conditions

Stocks can exhibit excessive volatility because their prices are
partially driven by fads and fashions

A study by Roll found that only one-third of the variation in stocks
returns can be explained by systematic economic forces

January effect


Many portfolio managers invest in riskier small stocks at the
beginning of the year and shift to larger companies near the end
of the year

Places upward pressure on small stocks in January
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Factors That Affect Stock Prices
(cont’d)

Firm-specific factors

Some firms are more exposed to conditions within their own
industry than to general economic conditions, so participants
monitor:

Industry sales forecasts

Entry into the industry by new competitors

Price movements of the industry’s products

Market participants focus on announcements that signal
information about a firm’s sales growth, earnings, or
characteristics that cause a revision in the expected cash flows