Vicentiu Covrig                               FIN303
             Facts about common stock
        Represents ownership
        Ownership implies control
        Stockholders elect directors
        Directors elect management
        Management’s goal: Maximize the stock 
           price
                             2
 Vicentiu Covrig                           FIN303
         Intrinsic Value and Stock Price
     Outside investors, corporate insiders, and analysts use a variety 
     of approaches to estimate a stock’s intrinsic value (P0).
     In equilibrium we assume that a stock’s price equals its 
     intrinsic value.
      - Outsiders estimate intrinsic value to help determine which 
        stocks are attractive to buy and/or sell.
      - Stocks with a price below its intrinsic value are 
        undervalued 
        Buy or Sell?
      - Stocks with a price above its intrinsic value are overvalued
        Buy or Sell?
                          3
 Vicentiu Covrig                             FIN303
  Different Approaches for Estimating the Intrinsic 
              Value of a Common Stock
     Discounted dividend model
     Corporate valuation model
     P/E multiple approach
     EVA approach (NOT for the exam)
                           4
  Vicentiu Covrig                                                             FIN303
                         Dividend growth model
      Value of a stock is the present value of the future dividends 
         expected to be generated by the stock.
      r  is the required rate of return (think the one from CAPM)
           s  
              ^         D             D             D                   D
              P          1             2            3      ...        
                0             1             2             3                   
                     (1r )        (1r )        (1r )              (1r )
                           s             s              s                   s
                                              5
  Vicentiu Covrig                                       FIN303
                Constant growth stock
      A stock whose dividends are expected to grow forever at a 
       constant rate, g.
          D = D  (1+g)1
            1    0
          D = D  (1+g)2
            2    0
          D = D  (1+g)t 
            t   0
      If g is constant, the dividend growth formula converges to:
               ^    D (1g)    D
               P     0         1
                 0
                      r - g    r - g
                       s       s
                                  6