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WEB CHAPTER 20
AN INTRODUCTION TO SECURITY VALUATION
I. Theory of Valuation
A. Stream of Expected Returns (Cash Flows)
1. Form of Returns – earnings, cash flows, dividends, interest payments, or capital gains
2. Time Pattern and Growth Rate of Returns – money has a time value
II. Valuation of Alternative Investments
A. Valuation of Bonds
1. Present value of interest payments
2. Present value of principal repayment
B. Valuation of Preferred Stock
D. Why and When to Use the Discounted Cash-Flow Valuation Approach
1. Dividends
2. Operating free cash flow
3. Free cash flow to equity
All of the above cash flow techniques are very dependent on:
The rate of growth and the duration of growth of the cash flows
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b. The constant growth rate will continue for an infinite period
c. The required rate of return (k) is greater than the infinite growth rate (g)
H. Valuation with Temporary Supernormal Growth – cost of equity is used as the discount
III. Relative Valuation Techniques
A. Earnings Multiplier Model (or P/E ratio)
B. The Price/Cash Flow Ratio
C. The Price/Book Value Ratio
IV. Estimating the Inputs: The Required Return and the Expected Growth Rate
A. Required Return (k)
1. The Economy’s Real Risk-Free Rate (RRFR)
B. Estimating the Required Return for Foreign Securities
1. Foreign Real RFR
2. Inflation Rate
3. Risk Premium
C. Expected Growth Rate
1. Estimating Growth From Fundamentals