Computing the Price of Common Stock
"Computing the Price of Common Stock" refers to the process of determining the value of a company's common stock. This involves analyzing various factors such as the company's earnings, growth prospects, and market conditions to arrive at a fair price for the stock. Investors use this information to make informed decisions about buying or selling common stock in the financial markets.
8 Key excerpts on "Computing the Price of Common Stock"
eBook - ePubThe Handbook of Traditional and Alternative Investment Vehicles
Investment Characteristics and Strategies
- Mark J. P. Anson, Frank J. Fabozzi, Frank J. Jones(Authors)
- 2010(Publication Date)
- Wiley(Publisher)
...What people are willing to pay for a share of stock today determines its market value. This theory of stock prices makes sense. If we could accurately forecast a company’s cash flows in the future, we could determine the value of the company’s stock today and determine whether the stock is over- or under-valued by the market. But forecasting future cash flows is difficult. As an alternative, what is typically done is to examine the historical and current relation between stock prices and some fundamental value, such as earnings or dividends, using this relation to estimate the value of a share of stock. In this chapter and the next, we look at common stock as an investment. We explain the fundamental factors of earnings and dividends and their relations with share price as expressed in such commonly-used ratios as the price-earnings ratio and the dividend yield, where stocks are traded, the mechanics of stock trading, and trading costs. In the next chapter we focus on common stock portfolio strategies. EARNINGS A commonly used measure of a company’s performance over a period of time is its earnings, which is often stated in terms of a return—that is, earnings scaled by the amount of the investment. But earnings can really mean many different things depending on the context. If a common stock analyst is evaluating the performance of a company’s operations, the focus is on the operating earnings of the company—its earnings before interest and taxes, EBIT. If the analyst is evaluating the performance of a company overall, the focus is upon net income, which is essentially EBIT less interest and taxes. If the analyst is evaluating the performance of the company from a common shareholder’s perspective, the earnings are the earnings available to common shareholders—EBIT less interest, taxes, and preferred stock dividends. Finally, if the analyst is forecasting future earnings and cash flows, the focus is on earnings from continuing operations...
eBook - ePubStudent-Managed Investment Funds
Organization, Policy, and Portfolio Management
- Brian Bruce(Author)
- 2020(Publication Date)
- Academic Press(Publisher)
...This assumption may not be consistent with every investment managers' investment philosophy. However, this implicit assumption is common among active managers who engage in security selection. Valuation Our discussion of valuation reviews the theory and application of several important valuation models. The common element among all valuation models is that they begin with the same first principle: The value of any asset is the present value of its future cash flows. That is, the scientific aspect of determining the intrinsic value of a stock is as simple as discounting the future cash flows from the stock. If its future cash flows and the appropriate discount rate are known, then the value of the stock is determined by the application of a time value of money principles. We start with this simple abstraction even though it relies on the naive notion that future cash flows are known. We first review the Dividend Discount Model, which uses dividends paid to the company's shareholders as the key cash flow paid by a stock. Beyond its usefulness in its own right, the Dividend Discount Model offers an important conceptual framework upon which we will base the other models. We next discuss the DCF approach using the firm's cash flows that are available to equity-holders. This model considers the cash flows to the entire firm and, therefore, models the value of the entire firm. The company's stock represents the residual value available to equity shareholders after all senior claims, such as those of bondholders, are paid. Finally, we discuss the use of earnings or earnings per share as a measure of cash flow. While not technically a cash flow, the use of earnings in firm valuations has its virtues, primarily from a practical standpoint. We conclude this chapter with a discussion of commonly cited valuation metrics...
eBook - ePubMoney and Banking
An International Text
- Robert Eyler(Author)
- 2009(Publication Date)
- Routledge(Publisher)
...Common stock is the classic type of stock market asset; it is traded with a value changing every day on the secondary market. It is considered common because each stock has ownership and voting rights, but only has the privilege of receiving dividends if paid; dividends are a disbursement of retained earnings by a firm. A firm is not obliged to pay common stockholders any dividends at all. This chapter looks at the pricing of equity positions, mainly stock prices. The parallel to bond pricing is made. The Capital Asset Pricing Model provides a method of estimating the expected rate of return, and ultimately the present value discount factor, for any capital asset. This model is generally used for stock pricing. A brief discussion of housing markets expands the definition of equity, where portfolio allocations and management complete this chapter. Stock market indices Before we tackle the issue of stock market pricing, let’s first look at something you are likely to recognize. The news focuses on the equity markets. Individual stock prices and movements may be highlighted, but the focus is constantly on an amalgamated value of stocks in different indices. An index number revolves around a number, generally 100, the value in a base period. Table 4.1 DJIA composite stocks, June 2009 The Dow Jones Industrial Average, or DJIA, is such an index. Thirty stocks make up this index; the DJIA is a weighted average of the combination’s value. These stocks are chosen and also replaced based upon their role in the overall financial markets as leading indicators of specific industries. Table 4.1 shows the most recent stocks that make up the DJIA. DJIA is just one of many such averages; every major investment bank, local newspaper, and pop financier worldwide follows some variation of a stock index for information about the equity market’s overall movement. Other indices include the NASDAQ, Standard and Poor’s 500 (SP500), Russell 2000, Wilshire 5000, and many others...
eBook - ePubValue Investing in Growth Companies
How to Spot High Growth Businesses and Generate 40% to 400% Investment Returns
- Rusmin Ang, Victor Chng(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...Chapter 7 Valuation—The Fourth Piece of the Puzzle The Valuation of a Stock The fourth and final piece of the puzzle is valuation —the financial projection. This is the most important piece to access once the other three pieces have been addressed. Here, valuation is what we call the final part of assessment before buying into a stock. Needless to say, every stock has a price tag. So, at what price is a stock considered cheap? This chapter serves to answer this question. Though we cannot expect to buy a stock at its absolute bottom, for example, in the 2008–09 crash, when the Straits Times Index (STI) was at its lowest, at 1,500 points, and sell it at its peak in 2010, when the STI had recovered to above 3,300 points, we can avoid doing the opposite. Many investors commit the mistake of buying high, when someone they know is supposedly making a killing in the stock market, and selling low, when prices start to dive. Now that you are aware that Mr. Market is subject to mood swings, you need to know how to make full use of its irrationality, in order to purchase stocks at bargain prices and sell when others are ready to pay a premium price. In order to do this, you need to know how to calculate the intrinsic value of the company based on a certain set of assumptions. Valuation can help you achieve this, so that you can buy a growth company when it is trading at a discount from its intrinsic value. In relation to the valuation of a stock, there are three types of valuation methods that we often use to determine growth companies: 1. Price-to-Earnings Ratio (PE Ratio) 2. Price-to-Earnings to Growth Rate Ratio (PEG Ratio) 3. Discounted Earning Model Now let us go through these valuation methods one by one. Why Earnings Are Used When valuing a growth company, it is best to use a metric like earnings per share instead of operation cash flow...
eBook - ePub- Robert Irons(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...There are two costs to stock: dividends and capital gains. So, the total yield on a stock is comprised of dividend yield and capital gains yield. Since stock returns are more volatile than interest rates, most stocks typically have required returns that are higher than the YTM on investment grade bonds. In this chapter, we learn the very basics of how to value a stock. The Fundamental Principles in Action FP1 states that an asset derives its value from the cash flows it will produce. For many stocks, the cash flows are the dividends paid to common shareholders. For stocks that do not pay dividends, the cash flow from assets (CFFA) valuation model will be discussed. FP3 indicates the inverse relationship between an asset’s yield and its market value. This is clearly reflected in the mechanics of the dividend discount model used to value a stock. FP2 asserts that risk and return are directly related, and so riskier assets require higher returns. This applies to stocks as well, and it can be seen in PR1 (relating value inversely to the discount rate). Since the required return on the firm’s stock is used as the discount rate in valuing the stock, stocks of higher risk will pay a higher discount rate, which will reduce the market value of the stocks. The Basics of Stocks As mentioned above, common stock represents ownership in the firm as well as a claim to the common dividends paid by the firm. Preferred shareholders do not have ownership claims, but they do have claims to the preferred dividends paid by the firm, and in the case of bankruptcy they get in line ahead of the common shareholders for claims against the firm’s assets...
eBook - ePub- Charles S. Mizrahi(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...Stock prices can have extreme short term price volatility (aka Mr. Market). 2. Yet, the underlying company’s financial statements are relatively stable. 3. So, a strategy of buying stocks when prices are significantly below the calculated intrinsic value of the company will produce superior results (aka buying with a margin of safety). 8 Professor Bruce C.N. Greenwald of Columbia Business School stated that value investing is relatively simple: A value investor estimates the fundamental value of a financial security and compares that value to the current price Mr. Market is offering. If price is lower than value by a sufficient margin of safety, the value investor buys the security. 9 How then does one figure out the “calculated intrinsic value of a company” so they can buy the stock below that value? There are basically three approaches one can take toward valuing a company. 1. Stock selling below reproduction cost of its current assets. 10 This approach requires one to go through the balance sheet of a company with a finetoothed comb. Many times what is acceptable for Generally Accepted Accounting Principles (GAAP) does not truly reflect the value of the asset. In addition, sometimes a company’s stock will trade for a lower price than the book value of the company. Ben Graham focused on this approach toward valuing a company. The main drawback is that it requires fluency in accounting and specialized knowledge so that you can properly value the assets and liabilities. 2. Private transaction and formula valuation. This approach establishes the price of the company based on what a company would realize if the sale was negotiated by a rationally motivated buyer and seller. For example, most money management firms are bought and sold based on a percentage of money under management. If money management company ABC has $10 billion under management, the going price would be established as 2 percent of assets under management, or $200 million...
eBook - ePubCorporate Valuation for Portfolio Investment
Analyzing Assets, Earnings, Cash Flow, Stock Price, Governance, and Special Situations
- Robert A. G. Monks, Alexandra Reed Lajoux(Authors)
- 2010(Publication Date)
- Bloomberg Press(Publisher)
...CHAPTER 5 Valuation Based on Securities Prices Financial markets should not be treated as a physics laboratory but as a form of history. —George Soros, “Anatomy of a Crisis” April 9, 2010 (at King’s College, Cambridge) TO ESTIMATE THE VALUE of a company’s securities, investors can study its assets, earnings, and cash flow—the subjects of our opening chapters. But another indicator of securities’ value—a deceptively simpler one—is their current price : the dollars and cents that other investors are willing to pay for them right now on the open market. This chapter is for prospective investors who already know about a company’s financial statements but who want to glean information from current stock prices as well. It may seem obvious at best—and tautological at worst—to say that a security’s current price tells you something significant about its value. But in fact what does price, by itself, really tell you? It indicates only what other investors are willing to pay during the time of the price: it sets a temporary floor for buying today. A security’s price shows the market’s expectations about the company right now. The real question for investors is, what will the price be in the future when it’s time to sell? Thus price-based analysis anticipates price change from the moment of purchase to the moment of sale, whether one day or 30 years hence. This analysis varies according to the investor’s theory of stock market values. This chapter compares different stock market value theories and explains their relevance to different kinds of investors. Overview of Securities Prices Public markets are the generally accepted mode for valuing securities, but the prices they set may miss the mark when it comes to true value. Lord John Maynard Keynes famously characterized the process of valuing publicly traded securities as a beauty contest...
eBook - ePubConcise Guide to Value Investing
How to Buy Wonderful Companies at a Fair Price
- Brian McNiven(Author)
- 2012(Publication Date)
- Wiley(Publisher)
...The factor having the greatest weight in determining value is the rate at which retained profits are reinvested in the business. The price of a business Each business is unique, so price cannot be determined by shopping around for comparables. Instead, the pricing of a business is frequently determined by factors unrelated to its economic condition, business performance or prospects. In the absence of the comfort of a reasonable degree of certainty, human emotions and irrational persuasions influence how people think and the decisions they make, leading to wide variations between price and value. The values that some boards obtain from independent experts when defending their board seats from a takeover offer and the excess price subsequently written off by the acquirer as valueless endorses this belief. But is such ignorance necessary? The void of information on stock valuation has fuelled the impression that the variables in a business make value impossible to determine; hence the fall-back position of referring to the price as the value. First, let’s consider some basics of financial arithmetic. Present value (PV) This is also referred to as net present value (NPV). The PV of a known future cash flow is determined by discounting the scheduled payments, including any future capital sum (principal redemption), over the period required for the receipt of each payment by an adopted RR. The resultant sum is the PV of the future cash flow based on the RR. The adopted RR will depend on comparable rates of return from similar investments, based on the certainty of the issuer’s obligations being met and the marketability of the security should you wish to sell before the due redemption date. In valuing a perpetual government bond paying $100 interest p.a., we might, depending on prevailing interest rates, adopt an RR of, say, 6 per cent...
