Presented By:
Muhammad Taimoor Baig
Uzair-ul-Atiq
Kashif Bashir
Salman Zafar
Syed Ali Raza
• Discounted cash flow method
• Relative Valuation Techniques
Valuation method used to estimate the
attractiveness of an investment opportunity.
Discounted cash flow tries to work out the
value of a company today, based on
projections of how much money it's going to
make in the future.
Also known as capitalization of income
method.
DCF analysis uses future free cash flow
projections and discounts them to arrive at a
present value, which is used to evaluate the
potential for investment. If the value arrived
at is higher than the current cost of the
investment, the opportunity may be a good
one.
Calculated as:
Estimate appropriate required rate of return.
Estimate amount and timing of future stream
of cash flows.
Usage to estimate the Present Value of a
security to be compared with a market price.
Several tried and true approaches to
discounted cash flow analysis, including
◦ Dividend Discount Model.
◦ Cash flow to firm approach.
Dividends are the only cash payments for
stockholders.
It’s a stock valuation technique.
The value of a stock is worth all of the future cash
flows expected to be generated by the firm,
discounted by an appropriate risk-adjusted rate.
According to the DDM, dividends are the cash
flows that are returned to the shareholder.
Estimated Value of a stock=
=
Deals with infinite stream of dividends.
Uncertain stream of dividends in terms of
their growth and time of occurrence.
Salman
Three Dividend Growth
Approaches
A zero growth model equates to fixed
dividends.
Constant stream of dividends with no growth
or change in dividends.
Exactly like the valuation process of preferred
stock.
Value of Stock =
=
Valuation model in which the dividends are
expected to grow at a constant growth rate
over time.
Value of Stock=
D1=D0 (1+g)
D1 is the dividend to be received at the end of
year one
Many firms grow at rapid rates for a few years
and then slow down.
Constant Growth is unable to deal with such
scenario.
It is necessary to monitor the fluctuating
growth in dividends to value the stock better.
Value of Stock= PV of dividend during usual
growth + PV of dividend at constant growth
rate model.
Some investors are not interested in dividends
but capital gains.
As in valuation, we are concerned with present
value of the future estimated prices. How to
incorporate the price affect in valuation.
Expected Price in future is already built into the
DDM and is not simply visible.
As the estimated price P0 is equal to the
discounted value of all the future dividends.
Estimated Price is called the Intrinsic Price.
◦ If IV< P0, stock is overvalued and should be avoided
and sold if held.
◦ If IV>P0, stock is undervalued and should be
purchased or held if owned.
◦ If IV=P0, implies equilibrium and rightly valued.
By comparison, advantage can be taken from
the relative inefficiency of the market.
Kashif
DDM is used to estimate the intrinsic value of
the stock.
Estimates are always involved in valuation
methods regardless who uses it and how it is
used.
All valuation models requires judgments and
estimates, because they all deal with an
uncertain future.
There are other approaches to valuation than
DDM.
Involves the similar pattern-an estimation of
future cash flows, discounted using discount
rate to today’s value to reflect the risk
involved.
One of the popular technique is the Cash flow
approach.
Can be employed by using a spreadsheet with
no complex mathematics.
Forecast expected cash flows.
Estimates for the expected free cash flows to the
firm.
Estimate the Discount Rate.
WACC is the discount rate in this case.
Calculate the Value of the Corporation.
Calculate the company’s residual value through
calculating discounted value of expected cash flow.
Calculate the Intrinsic Stock Value.
Dividing the free cash flows by the no. of shares out
standing to get the estimated stock value per share.
Produces the closest thing to an intrinsic stock
value.
Useful for a multiple stock comparison in a sector
and make useful distinction of valuable stock.
Relies on free cash flows, which is a very
trustworthy method to report earnings to
investor.
DCF seeks whether current stock’s prices are
justified by keeping track of company’s value.
Largely volatile to inputs.
If your inputs are fluctuating, the fair value
generated for the company won't be accurate,
and it won't be useful when assessing stock
prices.
Valuation based on the infinite stream of cash
flows in the future are not accurate.
DCF analysis is a moving target that demands
constant vigilance and modification.
uzair
Best-known and the most widely used
valuation approach.
P/E ratio is basically the number of times
investor value earnings as expressed in the
stock prices.
P/E Ratio= Market Value / EPS
Or
Market Value= P/E Ratio* EPS
Future earnings are estimated from the
current earnings as under.
◦ E1=E0 (1+g)
P/E can be calculated using DDM for the
constant growth model.
◦ P0= D1 / k-g
◦ Dividing both sides by E1
◦
Higher Payout ratio, higher the P/E
Higher the expected growth rate, higher the
P/E.
Higher the required rate of return, lower the
P/E.
But in reality movement in one direction is
offset by the other. E.g. More payout. less
growth.
A ratio used to compare a stock's market
value to its book value.
Also known as Price-Equity Ratio.
Calculated as:
A lower P/B ratio could mean that the stock is
undervalued.
This ratio also gives some idea of whether
you're paying too much for what would be
left if the company went bankrupt
immediately.
A ratio for valuing a stock relative to its own past
performance, other companies or the market
itself.
The ratio can vary substantially across industries;
therefore, it's useful mainly when comparing
similar companies.
Because it doesn't take any expenses or debt
into account, the ratio is somewhat limited in the
story it tells.
A measure of a company's financial
performance based on the residual wealth
calculated by deducting cost of capital from
its operating profit.
Calculated as.
= Net Operating Profit After Taxes (NOPAT) -
(Capital * Cost of Capital
Ali
DCF
Relative Valuation
Theoretically, DCF approach is correct, logical and
sound.
The best estimate of the current value of the
company’s common stock is the PV of cash flows to be
generated by the company.
Some analyst and investors feel it unrealistic.
Due to DDM, as no one can forecast dividends till
infinity with great precision.
Some invest doesn’t rely solely on dividends but also
want capital gains.
Relative valuation especially P/E or Multiplier
approach are popular valuation methods.
They are less sophisticated , less formal and
more intuitive models.
These models are relatively easier to use.
Understanding P/E will help investor to
understand DDM better because dividends
are drawn out of earnings.
Valuation of stock is difficult under best of circumstances.
Judgment is all based on estimates so errors are to be expected.
No one knows which particular valuation method holds true for
any particular stock and also the calculations of the valuation
model are correct or incorrect.
Finally, stocks are worth what investors pays for them. Valuation
may not hold true, but market price prevails.
