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Chapter 08 - Stock Valuation
8-1
Chapter 8
STOCK VALUATION
CHAPTER WEB SITES
Section
Web Address
CHAPTER ORGANIZATION
8.1 Common Stock Valuation
Stock Valuation Using Multiples
8.2 Some Features of Common and Preferred Stocks
8.3 The Stock Markets
8.4 Summary and Conclusions
ANNOTATED CHAPTER OUTLINE
8.1. Common Stock Valuation
A. Cash Flows
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Ethics Note: The importance of the components of the valuation
model is brought into sharp focus in a discussion of pension
funding decisions. Pension and Investments reports that in
Lecture Tip: Lively discussions can be generated in the area of
stock valuation and dividend cash flows. As the text points out, a
stock that currently pays no dividends may or may not have value;
a stock that will NEVER pay a dividend cannot have any value as
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B. Some Special Cases
An amount that grows at a constant rate forever is called a growing
perpetuity. The present value of all expected future dividends
under this scenario can be expressed as follows:
Lecture Tip: In his book, A Random Walk Down Wall Street, pp.
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Lecture Tip: If your students have had some calculus, you might
find it useful to derive the dividend growth model.
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Lecture Tip: Students often ask:
1. “How can g ever be assumed to be constant?” The answer lies
in the competitive equilibrium model of classical
2. “Why do we assume that R > g?” At least two answers are
possible. First, R may be less than g in the short-run. The
Lecture Tip: In this example P3 = D4 / (.1-.05). Some students
C. Components of the Required Return
Rearrange P0 = D1 / (R – g) to find R:
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International Tip: An interesting question arises as to the relative
importance of the components of required (or total) return in the
stocks of different countries when one considers the differences in
benefits from an information standpoint; however, students need to
recognize that not everything they read on the Internet is true. It is
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D. Stock Valuation Using Multiples
8.2. Some Features of Common and Preferred Stocks
A. Common Stock Features
Shareholders have the right to elect corporate directors who set
corporate policy and select operating management.
Chapter 08 - Stock Valuation
Lecture Tip: Large institutions, such as mutual funds and pension
funds, used to remain on the sidelines when it came to corporate
control. However, several institutions have become much more
Other rights usually include:
Real-World Tip: The importance of the preemptive right was
driven home in November, 1996, to the shareholders of Marvel
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1. Payment of dividends is at the discretion of the board. A firm
Lecture Tip: The tax laws regarding dividends received by
individuals were revised for dividends received after 2002.
The “proper holding period” requires the stockholder to own the
shares for at least 61 days during the 121 day period surrounding
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B. Preferred Stock Features
Preferred stock has precedence over common stock in the payment
Real-World Tip: Here’s a gruesome-sounding security – the
“death spiral.” Actually, the name refers to convertible preferred
8.3. The Stock Markets
A. Dealers and Brokers
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Lecture Tip: Some students find it hard to grasp the relative
importance of primary and secondary market transactions. Suggest
Video Note: The “Financial Markets” video discusses how capital is raised and shows
an open-outcry market at the Chicago Board of Trade.
B. Organization of the NYSE
Prior to 2006, the exchange consisted of 1,366 members, said to
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Lecture Tip: The role of the specialist is an interesting one. He is
entrusted with the knowledge of pending buy and sell orders (in
Floor brokers – NYSE members who execute orders for
commission brokers on a fee basis
C. Nasdaq Operations
NYSE operations represent a premier example of the trading of
“listed” securities. Nasdaq operations, on the other hand, represent
the evolution of “over-the-counter” trading of securities that do not
rely on a physical market place.
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D. Stock Market Reporting
Lecture Tip: A useful assignment is to require students to obtain a
8.4. Summary and Conclusions
